Inflation clouded by volatile food prices, weather shocks: RBI Governor at MPC meeting

All six members of the monetary policy committee (MPC) flagged food inflation as a concern, prompting them to unanimously vote for continuing with the pause in policy repo rate at their last meeting, according to the minutes of the meeting released by RBI.

The MPC has left the repo rate (the interest rate at which RBI provides funds to Banks to help them overcome short-term liquidity mismatches) unchanged at 6.50 per cent in the five meetings it held so far in FY24. The last meeting was held from December 6 to 8, 2023.

RBI Governor Shaktikanta Das noted that moving forward, while food inflation has receded from the highs seen in July, it remains elevated.

“The overall inflation outlook is expected to be clouded by volatile and uncertain food prices and intermittent weather shocks....We have to remain highly alert to any signs of generalisation of price impulses that may derail the ongoing process of disinflation,” Das said.

While inflation is moderating, it still quite a distance away from our goal of reaching 4 per cent CPI on a durable basis.

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“The projected inflation (4.7 per cent) in Q3 (October-December) of next year, i.e., one year from now, is perilously close to 5 per cent. In these circumstances, monetary policy has to be actively disinflationary.

“Any shift in policy stance now would be premature and risky. Further, with past rate hikes still working through the economy, it would be desirable to closely monitor their full play out,” the Governor said.

Deputy Governor MD Patra cautioned that inflation remains highly vulnerable to food price spikes, as the spurt in momentum in daily data on key food items for the month of November and early December reveal.

“This repetitive incidence is causing the accumulation of price pressures in the system and could impart persistence, reflected in a left-tailed skew in the distribution of inflation.

“...In my view, food prices in India are the true underlying component of inflation,” Patra said.

The Deputy Governor observed that the recent GDP data release reinforces the view that the output gap in India has turned positive since the beginning of the year and remains so.

“This points to the likelihood of demand pull shaping the course of inflation outcomes in the period ahead, amplifying future supply shocks,” he said.

Restrictive monetary policy

Jayanth R Varma, Professor, Indian Institute of Management, Ahmedabad, said a restrictive monetary policy must be maintained long enough to glide inflation to its target of 4 per cent.

Further, as inflation drops well below the upper tolerance band, it is necessary to prevent the real interest rate from becoming excessive.

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Varma observed that at present, projected inflation two to four quarters ahead averages below 4.75 per cent. The prevailing money market interest rates of 6.75 per cent (close to the MSF rate) therefore represent a real interest rate of more than 2 per cent.

“Three years of high inflation do justify a strong anti-inflationary monetary policy, but in my view a real rate of 2 per cent clearly exceeds the optimal rate.

“In coming months, as we become more confident about the downward trajectory of inflation (apart from transient food price spikes), there would be a compelling case for continually calibrating the nominal policy rate so as to keep the real interest rate slightly below 1.5 per cent (on the basis of projected inflation 3-5 quarters ahead),” the Professor said.

Varma, who was the only MPC member to express reservation on the monetary policy stance “to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth”, said: “I believe that a stance is not needed at all at this stage. If at all there is a stance, it should be neutral.”

Ashima Goyal, Emeritus Professor, Indira Gandhi Institute of Development Research, Mumbai, said the recent state election results reduce uncertainty around national elections and policy so more investment plans should be fast-tracked.

But areas of weakness remain in consumption, IT and merchandise exports. Employment offers have slowed in IITs.

“If inflation sustainably approaches 4 per cent by the middle of 2024, real rates can easily become too high if nothing is done. A repo of 6.5 per cent in 2018 and tight liquidity with a headline inflation of around 4 per cent, even though core inflation was around 6 per cent, proved severely deflationary. Both headline and core inflation fell steeply over the next year,” she said.

In this meeting, however, Goyal voted for keeping the repo rate and the stance unchanged, in order to watch the impact of an expected rise in food inflation over the next couple of months, since repeated supply shocks are a concern.

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