On Friday, the Monetary Policy Committee (MPC) of the Reserve Bank of India unanimously decided to maintain status quo on the repo rate, which is a rate at which the RBI lends money to the banks. This made it the seventh straight policy review, which are bi-monthly events, where the MPC has favoured staying put on the benchmark interest rates. It represents the peculiar quandary for the RBI. On the one hand, repeated disruptions due to the pandemic have choked India’s economic growth momentum, which was already losing steam before the outbreak. On the other, retail inflation, the key metric that the RBI is legally mandated to control, has been at the edge of its comfort zone since late 2019. The RBI has been of the view that it will do “whatever it takes” to support economic growth and has characterised the inflationary spike as a “transitory” phenomenon. But this stance of prioritising growth over inflation-control is becoming increasingly difficult to maintain.
An initial reflection of this unease can be seen in the lack of consensus among the six MPC members when it came to the RBI’s overall stance. While five members voted to persist with the “accommodative” stance “as long as necessary to revive and sustain growth on a durable basis”, one member — Jayanth R Varma — expressed reservations. At the heart of the matter is the inflation trajectory and how long it can be characterised as “transitory”. In the policy statement, the RBI upped the inflation forecast for the current financial year from 5.1 per cent (as assessed in June) to 5.7 per cent — that is, just 30 basis points below the RBI’s comfort zone. But perhaps the biggest worry comes from the fact that this year’s high inflation is coming on the back of high inflation a year ago. Moreover, this spike in prices is happening when overall demand hasn’t taken off as yet. Add to these the projection that global demand and commodity prices are expected to rise. All these factors raise the chances of inflation-control becoming much tougher in the future.
The trouble is, economic growth is far from exhibiting a sustained recovery. While the RBI’s GDP growth forecast for 2021-22 is unchanged at 9.5 per cent, the fine print shows that it has dialled down the growth expectations for each of the coming three quarters. But if inflation does not come down, it is only a matter of time that the RBI raises interest rates.
This editorial first appeared in the print edition on August 7, 2021 under the title ‘An uneasy stance’.