The Monetary Policy Committee of the Reserve Bank of India is scheduled to meet in the first week of December. With various economic indicators indicating that growth has slowed down considerably over the past few months, the consensus so far has been that the MPC will cut the benchmark repo rate for the sixth straight time in December, bringing it below 5 per cent. It was expected that this accomodative stance would continue in the next year as well until there was firm evidence of a broad-based pick-up in growth. But the sharper than expected spike in headline retail inflation in October has complicated the policy choices before the MPC. Data from the National Statistics Office shows that headline retail inflation edged up to 4.62 per cent in October, up from 3.99 per cent in September, largely on the back of higher food inflation. This upswing, which is unlikely to reverse in the coming months, has created uncertainty over the future course of monetary policy.
The inflation data shows that food inflation has jumped to 7.89 per cent in October, up from 5.11 per cent in the previous month, driven by a surge in vegetables prices, especially of onion and tomatoes. This surge is unlikely to subside. Food inflation is likely to remain elevated over the coming months, driving up headline retail inflation. Core inflation, which is essentially inflation excluding food and fuel, has moderated further, however, signaling continued weakness in demand. In its last policy review, the RBI had lowered its estimate for growth this year to 6.1 per cent, down from its earlier assessment of 6.9 per cent. This estimate was based on growth coming in at 5.3 per cent in the second quarter, and ranging between 6.6-7.2 per cent in the second half of the financial year. But there is little possibility of the RBI’s projections materialising as various high frequency indicators suggest that growth is likely to fall below 5 per cent in the second quarter. Thus, the MPC finds itself in a peculiar position of having to address the growth slowdown while inflation rises.
Going by current trends, with little possibility of a meaningful recovery in the near term, the situation warrants further monetary accommodation. So, while the MPC should carefully assess the trajectory of food inflation, its primary concern should be to arrest the slowdown. It should frontload the rate cuts in its December policy, though the magnitude of the cut will depend on the extent to which growth deviates from the RBI’s own projection. The shift to external benchmarking should lead to a quicker transmission of the cuts to the broader economy.