A watchful pause

MPC is prepared to act if required

The outcome of the meeting of the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) on Thursday checked all the necessary boxes. As was widely expected, the six-member committee left the policy repo rate unchanged at 6.5 per cent, despite the anticipated surge in the Consumer Price Index-based inflation rate at least for July and August. The MPC, in fact, also revised its inflation projection for the second quarter of this financial year to 6.2 per cent, which is higher than the upper end of the tolerance band. However, in spite of the expected surge, the MPC rightly decided to see through it because the rate is primarily being driven by food prices, particularly vegetables, and they are expected to moderate in the coming months. The MPC also rightly noted the need to remain watchful and be prepared to act if the need arose. There are risks from the uneven distribution of rain and the possibility of an El Niño event, which could put pressure on farm output and prices.

Although the MPC rightly decided to wait and watch as more clarity on inflation conditions would emerge in the coming weeks, the revised inflation projection warrants a discussion on the sufficiency of monetary policy action taken so far. The MPC’s revised projection indicates that the inflation rate is unlikely to come below 5 per cent at least till the first quarter of 2024-25. Even as the cumulative repo rate increase of 250 basis points is still working through the system, the MPC will need to deliberate in the coming meetings whether it will be sufficient to attain the 4 per cent inflation target on a durable basis. One of the comforting factors in this context could be the lower rate of core inflation. However, there is always a chance of sustained higher food inflation getting generalised. Although the possible need for further rate increases will be known in the coming months, it can safely be assumed at this stage that there is practically no possibility of a rate cut until at least the middle of next financial year. The RBI also did well to impose an incremental cash reserve ratio requirement on the increase in net demand and time liabilities in the banking system between May 19, 2023, and July 28, 2023. This temporary measure is intended to absorb excess liquidity from the system in the wake of the return of Rs 2,000 notes. Excess liquidity in the system can affect inflation outcomes.

While the near-term inflation outlook has worsened somewhat unexpectedly, growth projections would also require policy attention. Considering the below-trend global growth, the headline gross domestic product growth rate at 6.5 per cent for the Indian economy this financial year looks respectable. However, the RBI’s quarterly projections show the growth rate will decelerate from 8 per cent in the first quarter to 5.7 per cent in the fourth quarter. Although balance sheets of banks and companies have improved significantly and there are early signs of private-sector investment revival, the subdued global environment will be a drag for India’s medium-term outlook. Thus, the policy focus should be on minimising the impact of the global slowdown. Although this would require interventions principally from the government, the RBI on its part did well to reiterate its commitment to attain the 4 per cent inflation target and protect financial stability. Both will support long-term economic expansion.