RBI puts rate cuts on ice

Mumbai: Rising price pressures dominated discussions at the monetary policy review earlier this month, with members repeatedly cautioning against generalised inflation risks, when the panel voted to raise the benchmark repo rate by 25 basis points to 5.50%.

In his comments, Reserve Bank of India (RBI) Governor Sanjay Malhotra said that there are increasing signs of generalisation of inflation as 37% of the commodities in the consumer basket had inflation above 4% in August, up from merely 20% in March.

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"While core inflation increased from 3.9% in July to 4.2% in August, core inflation, excluding precious metals, increased to 2.9% in August, driven by a strong momentum of 0.5%. Underlying inflation, as measured by core ex precious metals is also anticipated to move above target in the coming months. This indicates a normalisation of inflation from the benign levels seen earlier," Malhotra said.

He also voted to change the stance of the monetary policy committee (MPC) to calibrated tightening from neutral signalling that rate cuts are off the table in the near term and policy action ahead can only be a rate hike or a pause.

In her statement deputy governor Poonam Gupta inflation at this point in time is mostly driven by external supply-side shocks, with insignificant signs of it becoming entrenched or impacting inflation expectations. "Yet, with projections indicating the likelihood of headline inflation hitting the upper tolerance limit of 6%, one may not want to wait for more definitive evidence of generalisation, and instead be mindful of the fact that monetary policy works with a lag," Gupta said.

ET Bureau

Pricing it in

She said that domestically weather-related adversities and global oil and commodity prices may continue to put upward pressure on headline inflation requiring a larger pass-through of input costs to output prices. "Under these circumstances, it is conceivable that a further increase in the policy rate might be needed to keep inflation low and inflationary expectations anchored. The pace, extent, and duration of such actions would depend on the incoming data on inflation, its diffusion, and evidence of second-round effects," she said, backing a change in stance.

External members Nagesh Kumar and Ram Singh acknowledged the inflation challenge due to factors like deficient monsoon, rising crude and metals prices but voted against the change in stance.

While Kumar said that inflation does not show any signs of overheating of the economy nor of generalisation and in view of the geopolitical and trade policy uncertainties a neutral stance remains appropriate.

Another external member Ram Singh also opposed the change in stance saying that it may signal an extended cycle of rate hikes. "This, in turn, can neutralise the benefits of growth-supportive monetary and fiscal policies in the recent past. Current inflation is primarily due to supply-side factors, rising fuel, food, and commodity prices, and their effects. The classic signs of economic overheating-such as a wage-price spiral or demand-driven capacity overstretch or abnormal growth in private consumption and capex-are largely absent," Ram Singh said.

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MPC member Saugata Bhattacharya expressed concern on India's external balance, given the tight global financial environment. "At the very least, maintaining a certain gap between India and G7 interest rates is important for attracting debt capital flows. At the same time, too rapid a policy rate adjustment risks constricting growth and hence growth-led capital flows...The current and forecast level of real interest rates do not seem consistent with levels required for ensuring price stability. The real natural rate of interest (pertaining to Q4 of FY23-24) estimated this to be 1.4-1.9%," adding that all available information indicates a strong economic case this time for tightening monetary policy, to bring inflation closer to the target.

RBI executive director and MPC member Indranil Bhattacharyya said there is increasing evidence of pass-through of input cost pressures in segments like restaurants and cooked meals.

"Greater pass-through is expected going ahead, especially when demand conditions are strong. Therefore, the inflation outlook merits greater attention, given supply side pressures from crude and food prices are unlikely to relent quickly. With demand holding strong and in the wake of strong growth in monetary and credit aggregates, the interplay of both supply and demand factors could ratchet up inflation pressures significantly in the period ahead," he said in his statement asking for setting aside the "cautiousness bias" and hiking rates.

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