MPC will hold key inflation, economy clues
More than the rate decision, the Reserve Bank of India’s projections and stance may show way forward after Budget
Exactly seven days after the presentation of the Union Budget, the Monetary Policy Com-mittee (MPC) of the Reserve Bank of India (RBI) will release its bimonthly monetary policy resolution on Wednesday that may hold key clues for the economy. While the Budget maintained its focus on boosting India’s long-term growth prospects by continuing to increase the allocation for capital spending, and credibly so, the overall fiscal impulse, given the reduction in fiscal deficit, is negative. This comes at a time when the global economy is losing momentum.
How should MPC set its future course in this context? Most analysts expect RBI to administer another interest rate hike of 25 basis points at its current meeting — it will take the cumulative hike in the current cycle to 2.5 percentage points — and then hit pause. Has this approach worked? Headline inflation has started coming down, but core inflation — it tracks the prices of the non-food, non-fuel part of the Consumer Price Index (CPI) basket — continues to remain above the 6% mark. This means that the economy is not out of the woods as far as inflation is concerned. To give credit to RBI, inflation expectati-ons have not increased drastically after MPC started administering rate hikes. Its effects on inflation notwithstanding, the increase in interest rates is bound to generate headwinds for domestic growth. This will only add to the growth headwinds from the slowing global economy via the export route, and the gradual withdrawal of fiscal stimulus.
Should MPC reverse course to support domestic growth given this situation, and consider a reversal of rate hikes sometime later this year? The answer to this question is more complicated than what a text-book trade-off between growth and inflation — the basic premise of inflation targeting — tells us. The global economy continues to show turbulence, more so in currency and financial markets, than in commodity markets. This necessitates that RBI maintains extra vigilance in making sure that its trade-off between domestic growth and inflation is in accordance with its responsibilities to maintain external economic stability. Any attempt to prioritise one without doing diligence about the impact on the other could do more bad than good. The best way to maintain this fine balance is to adopt a gradualist and data-driven approach to policymaking rather than committing oneself to a predetermined course.