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MUMBAI : More interest rate hikes are coming and the resulting spending squeeze will slow down the economy, members of the Reserve Bank of India’s Monetary Policy Committee noted, as the central bank joins a global war against inflation.

The committee raised the benchmark repo rate by 50 basis points early this month, the second such increase in two months. It had first raised rates by 40 basis points at an unscheduled meeting in May.

“In the process, spending will slow down, so will demand, and so will the economy. The objective should be to take the repo rate to a height that is at least above the four quarters ahead forecast of inflation, knowing that monetary policy works with lags. Concomitantly, it is important to condition public perceptions and expectations that growth will be closer to 6% than to 7% in 2023-24, as a result of monetary tightening," said RBI deputy governor and MPC member Michael Patra.

Runaway inflation could corrode the foundations of the recovery that is gradually gaining traction, Patra said. In India, inflation above 6% deters investment decisions, causes depositors to worry about negative returns and, hence, shift to time-tested holders of value like gold. This, he said, triggers capital flight and exchange rate depreciation, raising imported inflation. Inflation as measured by the Consumer Price Index (CPI) came in at 7.04% in May, the fifth straight month above RBI’s flexible target of 2-6%.

“Our endeavour should be to bring down inflation into the tolerance band by the last quarter of 2022-23 or the first quarter of 2023-24 and progressively align it to the target during the course of 2023-24. This should minimize the loss of output," Patra added.

MPC’s lone hawk, Jayant Verma, who had called for a 100 basis point rate hike, believes MPC still has a lot of catching-up to do.

“Between April and now, the MPC has raised the policy rate by 90 basis points, but during the same period, the RBI’s projection of inflation for the year 2022-23 has risen by 100 basis points from 5.7% to 6.7%. The real policy rate, therefore, remains more or less where it was in April. This reminds me of Lewis Carroll’s adage that we must run as fast as we can, just to stay in place; and to go anywhere, we must run even faster. Clearly, more needs to be done in future meetings to bring the real policy rate to a modestly positive level consistent with the emerging inflation and growth dynamics," Verma said.

According to MPC member Ashima Goyal, at the current stage of recovery, however, the one-year ahead real rate must not be more negative than -1%.

“A 50 or 60 basis point hike would achieve this, while looking through part of the spike in 2022, even as further supply-side movement and clarity on global developments are awaited. Such a real interest rate, while not dampening the recovery much, will prevent a possibly further inflationary rise in demand and unsustainable current account deficit," said Goyal.

The new MPC member Rajiv Ranjan said fighting inflation should be the joint responsibility of the RBI and the government.

“In this context, with monetary policy prioritizing price stability and fiscal policy emphasising on quality of expenditure through capex, the economy becomes the net beneficiary. Thus, it may be important for the government—both Centre and states—to successfully complete their budgeted capex plans and work through their counter-cyclical policy levers to ensure a soft-landing for the economy amidst monetary tightening to rein in inflation," said Ranjan.

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