Upside risks to inflation in the near term provided rationale for a pause

Reserve Bank of India Governor went along with the unanimous recommendation of the members of its monetary policy panel to maintain status quo on interest rates in the Monetary Policy Statement for 2014-15.

The eleven member Technical Advisory Committee (TAC), which is headed by Governor Raghuram Rajan, on monetary policy said upside risks to headline inflation in the near term provide the rationale for a pause.

In its first bi-monthly monetary policy statement, which was released on April 1, the central bank kept the policy repo rate, the interest rate at which it provides liquidity support to the banking system, unchanged at 8 per cent.

The rationale for the status quo in the policy rate include high order of political and economic uncertainty engendered by the forthcoming national elections; the policy stance not being tight enough as the real policy rate is still negative; anchoring inflation expectations; sticky core CPI; and the large fiscal deficit.

Inflation: persistently higher

Members expressed concern on inflation in India being persistently higher than in other countries.

On the inflation outlook, most of the Members noted that moderation in vegetable prices drove the recent softening of headline inflation and this is unlikely to be sustained.

The members observed that there are clear upside risks to inflation, such as suppressed pricing in electricity, LPG and diesel; impact of hailstorms on potato prices, if not on onion; increase in NREGA (National Rural Employment Guarantee Act) employment guarantee by 50 days; and decline in female labour force participation.

Inflation excluding food and fuel is sticky since inflation in housing, education and medical care is still elevated.

Inflation may surge after Oct/Nov

As the economy picks up, there will be an increase in these components and inflation may surge again after October/November 2014, as per the minutes of the meeting by the RBI.

Members cautioned that the Reserve Bank needs to be watchful of the decline in retail inflation to ascertain if the decline is likely to be on a sustained basis.

Muted GDP growth

On the domestic front, Members’ outlook was that real GDP growth will be muted. The manufacturing sector is stagnant. Since exports and imports are declining, the manufacturing outlook is also weak. Members sensed that investment may pick up as stalled projects take off after the election results.

To manage the risks associated with capital outflows, most of the Members recommended that the Reserve Bank should focus on building up foreign exchange reserves.

Members emphasised that the nuancing of forward guidance is important. Forward guidance should aim at maintaining interest rate stability, while recognising the challenges of dealing with capital outflows and supply shocks in the process of negotiating the disinflation path set out for January 2016.

(This article was published on April 25, 2014)
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