The frequency of RBI policy meetings has increased but the excitement surrounding them has not come down. The January policy review has become particularly interesting as after almost a year, the classic central banker’s dilemma of upside inflation and downside growth risks are setting the backdrop. It is true that today inflation is primarily driven by food prices and RBI measures are thought to have little direct impact on supply-side factors.
So the question arises, why use monetary policy at all? Sustained high inflation, like the way we have witnessed over the last year (regardless of its source), can lead to a destabilising wage-price spiral in the absence of rapid growth in productivity. Over the medium term, lower real returns may discourage savings, further depressing the potential growth rate. Also, if we think eight per cent wholesale price index (WPI)-based inflation to be the critical threshold where alarm bells start ringing, this is the longest period in the last 15 years when it has stayed above that mark. Inability to bring down inflation to RBI’s comfort zone can dent the credibility of the central bank and credibility is vital to anchor inflationary expectations. If the inflation genie gets out of the bottle, it is difficult to put it back!
Monetary policy action can also be justified as a proactive step because core inflation has started inching up. Key input prices for steel, coal, cement, rubber, etc, have risen and can feed into output prices in sectors where pricing power is present. Any shock to fuel prices and the inflation scenario can turn ugly again. It is becoming apparent that investors are getting worried about the tail risks of structurally high inflation derailing the growth trajectory. Any increase in interest rates at this juncture is likely to soften growth. However, moderation in growth can in principle be calibrated. On the other hand, if RBI goes soft, stubbornly high inflation can exact a larger price from growth and the outcome could be more unpredictable.
Unfortunately, with the economy hitting a soft patch, RBI probably does not have the option of pushing harder on the brakes. So, we do not consider a 50-bps rise in the January policy as our baseline scenario but emphasise that more rate increases are yet to come.
The writer is Regional Head of Research, India Standard Chartered Bank
