RBI policy meeting: With core inflation remaining sticky, MPC has good enough reason not to delay a rate hike

The Monetary Policy Committee (MPC) will announce the outcome of its bi-monthly policy review on Wednesday (1 August). What will be the rate action this time? At the time of the previous policy review, the MPC had stressed on two points for future action — the course of retail inflation and the impact of MSP on prices.

Representational image. Reuters.

Representational image. Reuters.

Now, with the appearing certainty in both these factors, most economists are betting on a status-quo on rates while some expect a rate hike, against a backdrop of rising inflation and the likely impact of the union government hiking the minimum support prices (MSP) for kharif crops.

It is difficult to predict the outcome but there is another component that the rate panel will certainly worry about — core inflation or non-food manufacturing inflation. 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 thus far.

This should influence the rate setting panel that has set its eyes on four percent medium target on retail inflation, and if the committee finds enough consensus on this point, one can expect a rate hike this time. Retail inflation has been on an upward trajectory, inching up to a five-month high of five percent in the month of June, mainly due to fuel prices.

Inflation escalating, on the other hand, is a bigger concern at this stage because the full impact of the minimum support price (MSP), 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 monetary policy committee will watch the impact of the rains, MSP and, more critically, the course of fuel prices to decide the course of interest rates. If the MPC is convinced that high inflation is here to stay it may choose to hike rates. In the June monetary policy, the Reserve Bank of India (RBI) cited five major risk factors for inflation -- the uncertainty in global markets, significant rise in households’ inflation expectations as gathered in the May 2018 round of the Reserve Bank’s survey, the staggered impact of HRA revisions by various state governments, the MSP impact and the impact of the monsoon going off-track. The MPC hiked the policy rate by a token quarter percentage point emphasising that it wants to keep inflation in the range of four percent. But a rate hike will irk the growth-lobby that will argue that the cost borrowing will go up further.

At the 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.

In an election year, in the backdrop of slowing growth, this poses a dilemma before the MPC whether to hike rate or not. But, there are external factors as well that will come into play from this point, mainly the course of crude oil prices and the US Fed's signals on interest rates. India remains highly vulnerable to these two factors particularly at a time when the rupee is in free-fall, seeking new lows every other day.

If the MPC needs to choose between inflation concerns and growth, it has always favoured the former, if one looks at past evidence. If a rate hike needs to be done (which seems to be the case given the core inflation figures), it’s better to do it now rather than delaying it, and thus making the policy course clear to the financial markets.

(Data support by Kishor Kadam)

Updated Date: Jul 30, 2018 12:11 PM

Also See