Is it time for RBI to go for a rate hike?
The ingredients are all therea stubborn inflation, likely US Fed interest rate hike, rising commodity prices. But will RBI's monetary policy committee take the plunge?
In the latest meeting of the monetary policy committee that sprung the surprise shift in the Reserve Bank of India’s (RBI’s) policy stance, this question seems to be at the back of the six members’ minds, if you go by the minutes of the meeting.
For starters, all the members flagged off their concerns over sticky core inflation and some sounded ominous too. RBI governor Urjit Patel, newly instated deputy governor Viral Acharya and executive director Michael Patra all sounded the alarm over the stubbornness of core inflation, adding that this threatens the central bank’s ability to achieve the 4% medium-term target.
Patra’s comment that a deviation of retail inflation from the tolerance limit of 2% and 6% cannot be allowed beyond three quarters suggests that the central bank is worried this is a possibility. And it should be, given that core inflation has been higher than headline inflation for five straight months now. He also warns of a “perfect storm" as upside risks from global financial turbulence, rising international crude oil prices and a less-than-normal southwest monsoon materialize.
This is not the first time that the central bank has been spooked by core inflation. For the best part of former governor Duvvuri Subbarao’s tenure, core inflation was notoriously high and had toppled many a forecast of RBI. It also gave grief to former chief Raghuram Rajan, who followed Subbarao. But the core had collapsed to its lowest under Rajan’s regime since the inception of the new retail inflation index.
This time around, the RBI members have the backing of the other three as well in their inflation worries. Both Chetan Ghate and Pami Dua add the mix of an upswing in economic growth and inflation in advanced economies, especially the US. The chart on flash Purchasing Managers’ Indices in this section only proves them right. Upbeat data will only prod the US Federal Reserve into hiking the interest rate and push commodity prices higher.
The impact of demonetisation has been swept away in this sea of worries. The effects of the currency purge indeed look transitory and Patra’s point of reflationary effects of remonetization hits home. However, Ghate warns that gradual permanent effects of the currency withdrawal through wealth destruction still remain clouded.
So will the next meeting deliver a rate hike? The ingredients are already there in the form of a stubborn and rising core, strong probability of Fed rate hikes, rising commodity prices, and the rebalancing of portfolio flows.
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