RBI says inflation remains high, ’important’ to contain within tolerance band in FY24

In the minutes of the MPC meeting which was released on Wednesday, it can be said, inflation is still very high and continues to pose the biggest threat for the macroeconomic outlook ahead. RBI deputy governor, Dr Michael Debabrata Patra also a member of MPC, said, it is important to contain India's consumer price index (CPI) within the tolerance band in 2023-24.

As per the RBI minutes, four MPC members voted for a rate hike including Patra and the governor Shaktikanta Das.

Giving his rationale as to why a repo rate hike was needed in February 2023 policy, Patra said, "over the year gone by, monetary policy actions have been undertaken and accommodation has been withdrawn to restore price stability."

He added, the impact of these actions is beginning to be reflected in the channels of transmission. This provides little comfort though, as barring the pronounced winter easing of vegetable prices, almost every other component of the consumer price index is showing a hardening of price pressures.

In fact, Patra revealed that statistical and exclusion-based measures of underlying inflation are actually showing an uptick. It is eminently likely that as the cooler weather gives way to summer, vegetable prices will turn up again as they usually do. Households sense this, as revealed in largely unchanged inflation expectations and muted discretionary spends, especially in rural areas. Businesses are accordingly encountering a moderation in sales and revenues.

With input cost pressures still being passed through into expenditures, Patra said, "capital spending remains restrained."

Thereby, Patra said, "the stance of monetary policy will need to remain disinflationary till inflation is returned to target."

Inflation has become the biggest elephant in the room since early 2022 for macroeconomic risks globally. In line with other major central banks, RBI has taken the rate hike cycle as well to tame inflationary pressure.

So far, in FY23, RBI has hiked the repo rate by 250 basis points, taking it at 6.5%. The latest hike would be 25 bps on February 8, 2023. MPC members have also continued to hold onto the "withdrawal of accommodation" stance.

The pattern of smaller size rate hikes but still maintaining "withdrawal of accommodation" stance --- gives an indication that the battle to bring inflation under the tolerance limit is not over yet.

According to Patra, combined with the drag on exports due to the retarding effects of slowing global activity, and the expected consolidation of fiscal spending, the prospects for growth in 2023-24 hinge around price stability, anchored inflation expectations, and improving supply responses across agriculture, industry, and services.

Although it seems to have peaked, Patra said, "inflation remains high and, in my view, it is the biggest threat to the macroeconomic outlook."

The fight against inflation is complicated by the global outlook, Patra added, "there is some consensus growing around a milder slowdown than earlier feared, although geographical disparities complicate the prognosis."

Patra believes the outlook for global inflation is turning more uncertain than before.

"While central banks expect only a stubborn easing, financial markets are betting on a more dramatic downturn as commodity price pressures ease and supply chains improve. Nonetheless, future shocks associated with the war and the pandemic are possible," he added.

In January 2023, India's consumer price index (CPI) climbed to the highest level in three months at 6.52% --- which is higher than the street's expectations. Also, inflation shot up from RBI's upper tolerance limit of 6%, after staying under this level between November and December 2022.

RBI's medium-term target for CPI inflation is 4% within a band of +/- 2%, while supporting growth. Hence, the upper tolerance limit comes to around 6%.

On the implications for policy, Patra said, "the MPC has to remain committed to its primary mandate."

He explained that the recent experience has amply demonstrated that low and stable inflation is the credible nominal anchor for a reinvigoration of growth. Moving the policy rate into restrictive territory at a resolute pace has provided the headroom to continue to moderate the order of rate increases.

Further, Patra added, "this enables us to assess the impact of our actions carefully while taking into account the risks around the outlook. It also demonstrates the credibility of our actions through carefully calibrated rate changes without any backtracks."

While keeping in mind the objective of growth, Patra said, "the foot must remain on the brake as we chart our future trajectory. On a pragmatic basis, it is important to at least contain inflation within the tolerance band in 2023-24 as the first milestone to be passed in aligning inflation with the target."

But the impact of the rate hike is yet to be faced fully.

Patra said, "While the full effects of monetary policy actions on economic activity are yet to be seen, increasingly it is becoming evident that inflation is weakening domestic consumption and investment as well as confidence."

After the January inflation print, Yes Bank economists in their report dated February 13, said, "the arrival of winter vegetable in February-March and government intervention to arrest cereal price rise may be comforting for food prices."

However, the economists added, "the core inflation is sticky at 6.3% for the 3rd consecutive month, validating RBI’s concern on the core. The RBI will see one more inflation print ahead of its April policy and this print heightens the probability of another 25bps repo rate hike."