Global inflation no excuse for lax policy, MPC now accepts

This is a relief particularly because it took some time for the RBI to accept that inflation was above the comfort level. It took an emergency meeting of the MPC in May 2022 to start the cycle of increase in interest rates. Prior to that meeting, the argument being forwarded was that increasing the rate can jeopardize the post-pandemic recovery of the economy. This thinking was evident in the minutes of the MPC meeting held in April 2022. Somewhat strangely, even after recognizing that several conditions in the global economy are “…imparting sizeable upside risks to the inflation trajectory and downside risks to domestic growth," it went on to assert that “Given the evolving risks and uncertainties, the MPC has decided to keep the policy repo rate unchanged at 4 per cent."

This argument did not hold much water for two reasons. One, high degree of liquidity in the economy did not quite light a fire for private investments. Two, the uncertainty it would cause in the economy if RBI were not seen keen on performing its mandated role of keeping inflation rate around 4 per cent would probably jeopardize the economy far more. Thus, it was a welcome change to read the Governor’s statement this time, where he noted “…the MPC stressed that sustained high inflation could destabilise inflation expectations and harm growth in the medium term."

Another argument that was being pushed forward earlier is that we are doing better than other countries, particularly the US. This is really facetious. There is no doubt that inflation right now is a global phenomenon, and that several global factors are at play. It is also true, that, for a change, India’s inflation rate is lower than that in the US. However, that does not mean monetary policy in India can be lax. Using the US as a reference in this case is wrong. It has a unique position in the world where its currency is seen as a safe asset. This manifests in the fact that even though the US is experiencing one of the highest inflation rates among developed countries, the US dollar is appreciating against a broad range of currencies. Moreover, there is an asymmetry in how monetary policy of US impacts India, and hence monetary policy in India needs to take that into account.

This is true not only for India, but for a large number of countries, both developed and emerging. For example, even the Swiss National Bank was forced to raise the interest rate by 50bps in June, surprising the markets, in spite of the inflation being about 3.3 per cent there that month–much low in global comparison, though higher than the target 2 per cent for that country.

Japan, still facing very low inflation, is one of the holdouts and this has resulted in a depreciation of the Japanese Yen by more than 16 per cent between March and July and is at the lowest level in more than two decades.

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The emergency meeting of the MPC held between May 2 and May 4 just before the scheduled meeting of the US Federal Open Market Committee, FOMC, indicates that the RBI recognizes this situation. The Governor’s statement following the rate hike last week says, “For emerging market economies (EMEs), these risks are magnified as they have to contend with both domestic growth-inflation trade-offs and spillovers from the most synchronised tightening of monetary policy worldwide," thus, making it clear that global monetary policy played a role in this latest increase by the MPC.

While initially the RBI may have been reluctant to take on the fight to keep inflation rate close to the mandated target rate of 4 per cent, it appears it has given up that position and is now focused on bringing the inflation rate to a lower level. This is what is expected of the central bank, and this is what is good for the Indian economy. This will go a long way in repairing the reputation of the RBI, which is a critical component in fighting inflation. The war on inflation is not yet won. Hopefully, the RBI will keep on this path.

Elsewhere in Mint

In Opinion, Manu Joseph replies to free-speech warriors. Mythili Bhusnurmath says MPC is out on a wing and a prayer. Long Story has a cheeky take on the jargon of stock market.