Editorial. MPC’s caution on inflation understandable

The Monetary Policy Committee’s (MPC’s) decision to hike the repo rate by 25 basis points to 6.5 per cent (an increase of 250 basis points since last May) was in line with expectations. Yet, there were two dissenters to this decision in a panel of six. While the dissenting members are likely to have favoured a pause on the ground that the rate hikes since May 2022 must be given time to transmit themselves, the reasoning behind Wednesday’s increase is easily understood. The MPC, as Reserve Bank of India Governor Shaktikanta Das said in his speech, felt persuaded to anchor inflationary expectations, in view of sticky core inflation (excluding food and fuel).

An RBI paper by Michael Debabrata Patra et al (December 2022) observes that what began as cost-push inflation in consumer goods turned into “generalisation of inflation”, as an “explosive rebound in demand for services took hold...” Therefore, taking global crude prices at $95 a barrel, the RBI has projected an inflation rate of 5.3 per cent for FY24, well above its comfort level of 4 per cent. The Q4 FY24 estimate of 5.6 per cent (5.7 per cent estimated in FY23) shows that the RBI is worried about inflation. The lower estimates for the first two quarters (5 per cent and 5.4 per cent) are influenced by the base effect, as conceded by RBI Deputy Governor Patra at the press briefing. The view seems to be — and correctly so too — that inflation must be slayed for growth to have an unhindered run.

The growth projection of 6.4 per cent for FY24 trends downwards over the four quarters, with no base effect at work here. The RBI has taken the ‘export drag’ into account. Yet, as the Economic Survey has shown, and as has been pointed out by the RBI, demand as well as private investment is picking up despite the rate hikes — perhaps prompting the MPC to prioritise inflation. RBI figures on sectoral deployment of credit show that that personal loans grew by 20.2 per cent (y-o-y) in December 2022 from 14.9 per cent a year ago, largely driven by housing and vehicle loans, outpacing credit growth to industry and agriculture — even as overall credit growth is up 16.7 per cent up till January. There is perhaps a demand-pull factor at work here. While the gap between credit and deposit growth has been cited as a concern, this is unlikely to pose liquidity problems, given banks’ SLR funds.

Indeed, the rate hikes along with government spending could spur deposit growth (now in double digits). The modest projected growth in the net borrowings programme of the Centre in FY24 (7-8 per cent over this fiscal, at just under ₹12 lakh crore) along with the focus on inflation, is likely to keep yields within reasonable limits. The RBI has kept its powder dry in view of global uncertainties, persisting with its ‘withdrawal of accommodation’ stance. It has rightly chosen to be data-driven in its approach. However, it should not delay a change of stance to ‘neutral’ for longer than is necessary.

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