Retail inflation measured by the Consumer Price Index (CPI) rose to 6.93% in July on account of higher food prices, breaching the RBI’s upper tolerance level of 6% for two consecutive months. The data for June was also revised upward to 6.23% from 6.09%.
The members reiterated the need to stick to the mandate to keep inflation below the upper limit of 6% and argued for a pause to see how growth and inflation play out.
The MPC also said ‘inflation whipsaw’ can become the dominant factor in next few meetings and that it would rather wait to study the emerging growth-inflation dynamics before moving once again to push growth over inflation.
Situation may worsen before improving
“Inflation surprises of recent months are undermining the MPC’s actions and stymieing its resolve to do what it takes to revive growth and mitigate the impact of Covid-19 on the economy. With inflation prints above the upper tolerance band, technical considerations under the monetary policy framework warrant a preoccupation with dealing with the conditions of failure,” RBI deputy governor Michael D Patra was quoted as saying in the MPC minutes, released by the central bank on Thursday.
The 24th meeting of the MPC was held during August 4-6, where all the members voted to keep the repo rate unchanged at 4%.
The prospect of an ‘inflation whipsaw’ – a phrase used by Markus Brunnermeier at the Princeton University – is probably the right way to look at inflation going forward, i.e., there are different inflation/deflation pressures that need to be watched carefully, said Chetan Ghate.
“On the upside, a perfect storm of cost push pressures, accommodative monetary policy, and adverse food supply shocks could lead to a pickup in inflation. On the downside, the paradox of thrift, i.e., forced saving pressure induced by a ‘de-facto’ lockdown, could be a potent disinflationary force,” Ghate said.
At the meeting, member Pami Dua said that with inflation carrying upside risks, CPI data for at least two or three more months would be crucial for clearly gauging the impact of supply-side disruptions and demand conditions on prices.
“I also feel that we should wait for some more time for the cumulative 250-bps reduction in policy rate since February 2019 to seep into the financial system and further reduce interest rates and spreads,” RBI governor Shaktikanta Das said.
“Given the uncertain inflation outlook, we have to remain watchful to see that the momentum in inflation does not get entrenched, which is also dependent on effective supply-side measures. As the economy continues to be in a fragile state, recovery in growth assumes primacy,” Das said.
The monetary authority has already front-loaded repo rate cuts as part of attempts to revive the economy, without success. Since the outbreak of the pandemic, the RBI has lowered the repo rate by 115 bps. One basis point is one-hundredth of a percentage point.
“I have been advocating a more cautious path for policy rate reductions since February 2019,” said Ghate. “However, I have been in a minority in the MPC. Inflation has now been above the upper band of 6% for a number of months. Notwithstanding large rate cuts to spur growth over the last year and a half, growth has steadily declined despite 250 bps in cuts since February 2019.”
Ghate called for a war on prices. “Future MPCs should not go soft on inflation. Going forward, monetary (and fiscal) policy will need to be used wisely with a clear understanding of what and what not they can achieve in terms of controlling inflation, smoothing out the business cycle, and limiting spurious economic volatility,” he said.
Rajendra H Dholakia said the primary mandate given to the MPC for inflation targeting has to be respected.
Both Patra and Das said the economic outlook was grim and recovery is likely to be slow and hesitant, with the situation likely to worsen before it gets better.
“The upticks that easing of lockdowns yield are likely to be ephemeral and vulnerable to flattening-out due to lack of underlying vigour,” Patra said.