Inflation-growth dynamics may enhance dilemma of monetary policy committee

A low 4.4 per cent gross domestic product (GDP) growth rate for the third quarter of the current financial year and above six per cent retail price inflation rate for over a year now, barring two months of November and December, may accentuate a dilemma before the monetary policy committee to go for another policy rate hike or not at its April monetary policy.

The fourth quarter would yield 5.1 per cent GDP growth rate if advance estimates of seven per cent growth for the full 2022-23 holds true. If it reduces to, say the projections made by the International Monetary Fund (IMF) at 6.8 per cent for the entire year, the fourth quarter would deliver just 4.4 per cent economic expansion, the same as Q3.

Moreover, the external situation has worsened with the financial system in distress in the US, China's growth slowing down and the UK narrowly avoiding recession. This along with domestic factors such as low demand may affect economic growth in the next financial year. While the economic survey has pegged the growth at 6-6.8 per cent with baseline projection at 6.5 per cent for 2023-24, many, including CRISIL, say it could be the lower end of the projection (6 per cent) which may actually materialise.

While many believe that the committee may go for another 25 basis point hike in repo at the April policy, Confederation of Indian Industry (CII) president Sanjiv Bajaj recently called for a pause in raising the policy rate to spur private investments.

While much of retail price inflation was driven by some food items, particularly cereals and milk, in recent months where rate hike may not have much impact, core inflation is still above six per cent which may not allow the MPC to lower guard on inflation.  MPC will meet from April three for annual monetary policy for 2023-24.

MPC is not alone in facing this predicament. This is faced by the Federal Reserve and other central banks worldwide.

There are expectations in the US that the Federal Reserve may raise the key interest rate by at least 25 basis points at a meeting of its Federal Open Market Committee (FOMC) later this month to tame inflation which remained sticky at six per cent in February.  However, there is also pressure on the Fed to go slow in the wake of the Silicon Valley Bank (SVB) crisis and the impact of rising interest rates on regional banks in the US.

On the other hand, the European Central Bank has raised interest rates by 50 basis points on Thursday as promised even as investors had called for a pause until sentiment disturbed by financial market chaos stabilises.

Back home, in the February policy review too, two of the six members of MPC -- Ashima Goyal and Jayanth R Varma had voted against the hike in the policy rate. The MPC has raised the policy rates by 250 points since May, 2022.

A unanimity in any rate hike decision at its April policy may still elude MPC.  

After a few quarters of aggressive tightening, inflation prints have eased while remaining above central bank targets, ICRA chief economist Aditi Nayar said, adding that after the boost from the post Covid recovery growth prints is now tepid in face of the cumulative tightening affected so far.

"For the MPC, while inflation is expected to moderate from March, 2023 onwards, the last two prints are above the six per cent upper threshold, based on which a non-unanimous rate hike can't be ruled out," she said.

However, the unfolding global events and the Fed's upcoming decision will be keenly watched, she said. The Federal Open Market Committee (FMOC) is scheduled to meet from today to take a decision on interest rates among others.

Anil K Sood , co-founder of The Institute for Advanced Studies in Complex Choices (IASCC), said if interest rates are lowered at this stage, it will not help accelerate GDP growth as consumption, as well as investment demand conditions, are not conducive for growth.

"If we choose not to raise rates and the Fed continues with its rate increase policy, as I expect the Fed to do, the rupee will depreciate further, resulting in higher imported inflation," he said.

Lower policy rate would also continue to feed domestic inflation by encouraging speculative investment in real-estate and commodity markets, he said.

"Since the Indian equity market is already over-priced, the lowering of policy rate would take it closer to the bubble territory, which would result in lower financial flows followed by the rupee depreciation – feeding imported inflation. Global financial investors are short-term investors even when they sell long-term growth narratives about India’s potential," Sood said.

Ranen Banerjee, partner, economic advisory services, and government sector leader at PwC India, said the monetary policy impacts come with a lag.

Given the accelerated policy rate increases, the central bank needs to pause for a quarter or two to observe the impacts.

One of the key reasons for the ensuing bank crisis is the unprecedented rate hike, he said and reminded that the European banks had made a petition to the ECB to pause rate hikes.

"The central banks should not again err on the side of caution as they had erred in keeping monetary policy too loose for too long in the wake of pandemic and dismissing elevated inflation numbers as transitional. A strong case for pause has emerged and the bank crisis may force the US Fed to go for a pause," he said.

For India, the case for a pause is much stronger as the inflationary pressures are not being driven by demand but several continued supply-side factors, Banerjee said, adding a correction of pump prices of fuel may be a better medicine to address inflationary pressures than further policy rate hikes.