RBI policy: Urjit Patel and Co. are looking to keep inflation on a short leash; the show isn’t over as yet

The Reserve Bank of India’s undying penchant with an inflation-centred monetary policy became evident yet again, when the Monetary Policy Committee (MPC) hiked the key lending rate, the repo, by another quarter percentage point on Wednesday. The repo rate now stands at 6.5 percent.

The dominant language in the policy statement was that of caution on the inflation front; and a sense of comfort on the growth scenario.

“The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months,” said the policy statement.

There was abundant warning on the upside risks of inflation; spiking crude oil price, global markets volatility, significant pick up in household inflation expectations and full impact of monsoon and so on. The message is clear; the rate hikes are not over yet, wait for another increase in the repo rate by end of the year.

The RBI wants to keep inflation on a short leash and that would mean another hike in the repo rate by end of the year, may be by another quarter percentage point.

There were enough reasons for most economists to bet on a status-quo on rates while some expected a rate hike in the backdrop of rising inflation and the likely impact of government announcing higher minimum support price (MSP).

Retail inflation, particularly the core inflation or non-food manufacturing inflation, has been marching up in the recent months. Core inflation stood at 6.28 percent in the month of June, the highest in at least three-and-a-half years and has shown no sign of fading off so far. This, certainly, influenced the rate setting panel leading to a majority consensus for rate hike. Retail inflation has been on an upward trajectory, inching up to a five-month high of five percent in the month of June, mainly hit by fuel prices. Inflation escalating, on the other hand, is a bigger concern at this stage because the full impact of the MSP (minimum support price), monsoon distribution, and high fuel prices are yet to reflect on the print. While vegetable and food prices have eased in June, the villain has been fuel prices.

“The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months,” the policy statement said. A rate hike is sure to irk the growth-lobby.

At last count, the index of industrial production (IIP) fell to a seven-month low of 3.2 percent in May on weak performance of the manufacturing and power sectors. A broad-based recovery in growth is not yet visible; particularly in the manufacturing sector critical for job generation. Services have been holding up the India growth story in recent years. But, the MPC thinks the economic recovery is in good shape and don’t require a rate cut boost at least for now.

Going ahead, the trajectory of inflation will hold the key for monetary policy formulation whereas concerns on growth have clearly taken a backseat. The MPC is in love with the four percent inflation target for the medium-term, and that means the rate hike show isn’t over as yet.

(Data from Kishor Kadam)