The Monetary Policy Committee’s decision to hike the repo rate by another 50 basis points to 5.9 per cent (cumulatively speaking, it is a sharp jump from a rate of 4.4 per cent earlier this May) is justified under the extremely stressed global and domestic circumstances. The shadow of global forces (read, currency stability) looms large on monetary policy, crimping space for the central bank to respond to domestic inflation and growth dynamics. Reserve Bank of India Governor Shaktikanta Das all but conceded this constraint by referring to the “third major shock — a storm” arising from aggressive rate hikes in advanced economies (apart from the Covid impact and the Ukraine war).
While Das was at pains to explain that the MPC’s decisions are domestically determined, the skittish rupee was certainly a factor that forced the MPC’s hand. As for domestic forces, the need to manage inflationary expectations was prime concern. The inflation outlook remains above the mandated level of 6 per cent for this fiscal (at 6.7 per cent) and may stay that way for a while. The MPC’s effort to anchor inflationary expectations is based on an assessment that demand-side impulses too are at work — besides supply-side pressures with respect to the food basket and the role of imported inflation in energy items. As Das observed on Friday: “There is a sustained revival in urban demand which should get a further impetus from unfettered celebration of upcoming festivals...” The demand push, the RBI anticipates, could also arise from typically higher H2 government spending. However, it is moot whether these domestic factors alone can explain a 50 basis points rise. While the growth forecast for this fiscal now stands at 7 per cent (against 7.2 per cent at the last MPC meeting), it is also to be kept in mind that inflation arising from supply shortages are quite unrelated to interest rate hikes. In this situation of all-round fluidity, Das has rightly said that the MPC will be data-driven, and not ‘forward guidance’-driven.
The Governor’s detailed explanation on forex management was meant to allay apprehensions on whether the RBI had the forex firepower to defend the rupee — and this was a welcome effort. He also dished out statistics which show that the decline in forex reserves over time was more a result of devaluation of the reserves rather than their being used up to defend the rupee. If the globally-induced pressure on the rupee persists, the RBI could consider steps other than rate increases, such as a special forex window for oil companies — besides the rupee-settlement option being pursued by the Centre. The RBI and MPC have also been at pains to explain that liquidity remains comfortable. In trying to balance growth and inflation, the RBI’s liquidity operations will have to be nimble. The Centre’s lower borrowings could help the RBI manage yields, curtail ‘crowding out’ and restrain money supply growth. Amidst the ‘third storm’, these are trying times indeed for central banks.