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Time for ultra-dovish monetary policy is over

Retail inflation breached RBI’s upper limit of 6% for the second straight month in Feb, fears of elevated wholesale prices feeding into the consumer side are far from over, and the war in Ukraine has added unexpected price pressuresPremium
Retail inflation breached RBI’s upper limit of 6% for the second straight month in Feb, fears of elevated wholesale prices feeding into the consumer side are far from over, and the war in Ukraine has added unexpected price pressures

The monetary policy committee, in its ongoing meeting, will have to address the upside risks to inflation along with the increasing pressure on rupee and growth

India’s monetary policy committee (MPC) faces an unenviable cocktail of challenges as it meets this week. Retail inflation breached the Reserve Bank of India’s (RBI’s) upper limit of 6% for the second straight month in February, fears of elevated wholesale prices feeding into the consumer side are far from over, and the war in Ukraine has added unexpected price pressures. The US Federal Reserve embarking on its rate hike cycle does not help either. But as inflation knocks on the door, so does the fear of slowing growth and a weak rupee as a fallout of the war. Against this backdrop, the panel needs to address some tough questions before it delivers its decision on Friday.

1. Still ‘transitory’?

For long, the MPC has been able to look through 6%-plus inflation prints as growth took a massive hit due to the pandemic. The underlying sentiment, as for other central banks, has been that the inflation was transitory. Even in its February meeting, the MPC held the view that fledgling growth still needed support, while inflation would eventually cool down.

But the key questions remain. In the present backdrop, is inflation still manageable without any measures? Can high wholesale prices and rising commodity prices be ignored? Can supply-side pressures ease before they get entrenched? Even core inflation has been stubborn. The MPC increasingly faces pressure to answer these questions more practically.

“The US Fed has turned decisively hawkish and acknowledged inflation is no longer transient," said Yuvika Singhal, an economist at QuantEco. “For India, CPI inflation may remain above 6% for the third consecutive year, and to be able to look through inflation yet again may be hard especially amidst second-order impact."

2. Crude shock

In February, the MPC saw inflation retreating to 4.5% in 2022-23. Many analysts called it an underestimate, and raised questions on the RBI’s estimate of crude oil prices. RBI Governor Shaktikanta Das, however, defended the forecast as “robust", even as he admitted to the possibility of “unforeseen" events. In an October 2021 report, the RBI had estimated crude oil prices at $75/bbl in the second half of 2021-22, while they were already $90/bbl. The war has taken it above $100, and even India’s basket of crude oil, which is a weighted average of two varieties, averaged $112/bbl in March.

The RBI will have to acknowledge and account for the surge at the meeting and communicate its revised estimate, which should lead to an upward revision in inflation forecast. Nomura expects headline inflation to average 6.3% in 2022. Other analysts also expect inflation above at least 5% in the current fiscal.

3. Household pressures

For two years, Indian consumers have consistently foreseen short-term inflation above or close to 10% in the RBI’s bimonthly household surveys. A slight moderation seen in the perceived inflation rate in January may well have reversed in the March survey, whose results are likely next week. The price pressures have been exacerbated by the sharp hikes in petrol prices. After a four-month hiatus ahead of Assembly elections in five states, oil marketing companies have swiftly hiked petrol prices by nearly 10/litre in just over a fortnight. Households’ inflation perception may also be shaped by the sequential rise in food prices in recent months. In March, 16 items out 22 for which the Department of Consumer Affairs details prices saw an increase, led by edible oils. It is essential that the MPC considers this, analysts said. “Anchoring of inflationary expectations may warrant a less dovish tone of the policy document," said Aditi Nayar, chief economist at ICRA.

4. Fiscal nudge

Surging input costs have forced several firms to hike product prices to protect their margins over the past year, while others have spoken about future hikes. A Mint analysis of Nifty 500 companies showed that 42 of 59 sectors saw raw material costs-to-sales ratio rise in the December-ended quarter. This could worsen further due to the war. A recent survey by S.P. Jain Institute of Management and Research found that operating costs among small and medium family enterprises increased by an average of 19.5% between mid-December and mid-March, with 85% of the surveyed enterprises reporting a rise in prices.

The MPC in the past has called for reduction in taxes on fuel prices to manage inflation. Some say such firm-level price pressures can also be addressed through fiscal measures such as tax reductions and subsidies. “The RBI will likely stress supply-side drivers and emphasize the use of fiscal levers to tame price pressures," said Barclays in a report on 5 April.

5. Capital outflows

External factors are adding to the RBI’s headache, with the rupee facing pressure and current account deficit widening. Many central banks have turned hawkish despite the war-led risks to growth, with the US Fed hiking interest rate by 25 basis points last month. This could trigger a flight of foreign investors from India if the RBI keeps rates at record lows any longer. While Brazil has benefited from being an early mover on rate hikes, India has already seen huge outflows.

To be sure, inflation in India is not yet as worrisome as in some other countries, and so, the RBI will need to eventually hike rates not just due to inflation, but more due to open-economy macro issues such as foreign capital, said N.R. Bhanumurthy, vice chancellor at Dr B.R. Ambedkar School of Economics University.

For now, analysts hope that the RBI at least sets the ball rolling towards a less dovish positioning.

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