Though all monetary policy committee (MPC) members had unanimously agreed that a policy repo rate hike is necessary to address concerns on the inflation front, one member — Jayanth Varma — showed preference for a 50 basis points (bps) hike. However Varma, a professor at the Indian Institute of Management (Ahmedabad), eventually voted with the majority for a 40 bps hike in the repo rate, according to MPC minutes released by the Reserve Bank of India.
At the off-cycle MPC meeting, held on May 2 and 4, all six members unanimously voted to up the repo rate from 4 to 4.40 per cent
The committee also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
“Since April, inflation risks have become more pronounced — both in terms of magnitude and in terms of persistence. On the other hand, the growth shock appears to be less severe than I initially feared.
Multiples of 25
“It appears to me that more than 100 basis points of rate increases needs to be carried out very soon. My preference therefore is for a 50 basis points increase in the repo rate in this meeting. The majority of the MPC is in favour of 40 basis points for reasons which are not very clear to me,” Varma said.
He said that whatever symbolic or psychological benefit there may be to keeping the hike below 50 bps, it is outweighed by the simplicity and clarity of moving in round multiples of 25 basis points. Additionally, reducing the current hike by 10 basis points would require an extra 10 basis point hike at some point (and perhaps sooner rather than later).
“Nevertheless, I have thought it fit not to dissent on this issue as the optimal rate hike is not something that can be calculated with mathematical precision and 40 basis points is not materially different from 50 basis points. I am thankful to the majority for not making my decision more difficult by choosing a 37.5 basis point hike (exactly mid-way between 25 and 50),” he said.
Shashanka Bhide, Honorary Senior Advisor, National Council of Applied Economic Research, observed that given the present assessment of the economy, monetary policy measures to break inflation dynamics have become necessary.
While such measures may affect growth momentum adversely in the short-term, overall external conditions require that domestic inflation pressures are contained quickly, he said.
Frontloading of hikes
Ashima Goyal, Emeritus Professor, Indira Gandhi Institute of Development Research, noted that inflation is high due to multiple supply shocks following each other. Even so, in an inflation-targeting regime, it is necessary to respond to inflation persistently above tolerance bands in order to anchor expectations.
In view of a reasonable recovery and the sharp rise in inflation, which will also raise inflation projections, frontloading of rate hikes is required to prevent the real rate becoming too negative, she said.
Risks from negative real interest rates include households buying gold, thus aggravating the current account deficit and hurting financial intermediation, cautioned Goyal.
Stagflation risks
RBI Governor Shaktikanta Das underscored that the worsening outlook of inflation warrants timely action to forestall second round effects which could lead to unanchoring of inflation expectations.
“Heightened uncertainty and volatile financial markets could also add to such unhinging of expectations. Accordingly, decisive and measured monetary policy response is necessary to avoid any unintended shocks to the economy,” he said.
MD Patra, Deputy Governor, felt that globally, stagflation could be transitioning from a risk scenario to a baseline scenario.
“Against this turbulent backdrop (of geopolitical spillovers) and with headline inflation persisting above the upper tolerance band for the third month in a row with signs of second order effects, the approach of reversing the extraordinary accommodation — in terms of both the policy rate and liquidity — that was undertaken in response to the pandemic is, to my mind, the right approach.
“When it is done, we will have reached a stage of neutral accommodation, in contrast to extraordinary pandemic time accommodation, from where the next stage responses can be calibrated,” he said.
Supply shocks
Rajiv Ranjan, Executive Director, RBI, said though the current price rise is essentially supply-shock driven, it cannot be ignored given its broad-based nature, spillover effects and persistence, which has a risk of unhinging inflation expectations.
Thus, at this stage of macroeconomic dynamics, it is necessary to reinstate the primacy of price stability and strengthen the credibility of monetary policy through demonstrable actions, he added.
Rajan said, “With economic recovery better entrenched than before, it is time to address the concerns on the inflation front, the dynamics of which has been fundamentally altered by the outbreak of the conflict in Europe.
“Though monetary policy may not have a direct influence on exogenous global commodity price shocks brought about by the war.”