“The need of the hour is calibrated monetary policy action, with a clear understanding that it is required for sustaining our medium-term growth prospects,” Reserve Bank of India (RBI) Governor Shaktikanta Das was cited as saying in the MPC minutes. “The financial and external sectors also continue to be under the Reserve Bank’s close watch.”
To be sure, the MPC deliberated upon its policy approach before the publication of the September consumer inflation print, which climbed due to persistent increase in food prices through a period of extended monsoons. The panel’s external members, while acknowledging the need to raise the cost of funds to anchor inflationary expectations, pointed to the need for an ideal pace of rate increases that wouldn’t crimp growth.
“A firm monetary policy reaction to inflation exceeding tolerance bands helps anchor expectations,” said external member Ashima Goyal, emeritus professor, Indira Gandhi Institute of Development Research.
‘Diverse Views on Rate Trajectory’
“But should the rise be taken upfront or staggered over time? If lagged effects of monetary policy are large, as in India, overreaction can be very costly…We are not yet at the terminal rate.” The RBI raised the benchmark policy repo rate, the rate at which it lends to banks, by half a percentage point to 5.9% in its September 30 monetary policy review as consumer inflation stayed consistently above the upper tolerance threshold of the mandated 2-6% range. “The minutes paint a clear divergence among MPC members on the future rate trajectory, with financial stability increasingly in focus,” said Rahul Bajoria, Economist, Barclays. “In the near term, given limited comfort on price trends, we see a case for further rate tightening, but possibly by less than the latest 50-basis-point hike.”
Goyal highlighted the fact that it takes time for the harmful effects of a rate action to become clear, and are difficult to reverse.
“Gradual, data-based action reduces the probability of over-reaction,” Goyal said. Taking Indian repo rates too high imposed heavy costs in 2011, 2014 and 2018, when a credit and investment slowdown was aggravated.
“It is necessary to go very carefully now that forward-looking real interest rates are positive,” she said.
External member Jayant Varma, professor at the Indian Institute of Management Ahmedabad (IIM-A), batted for policy rates around 6% and then a pause as monetary policy acts with lags of three-four quarters, with the peak effect taking as long as five-six quarters to manifest.
“It may well turn out that even more monetary tightening is required, but it does make sense to wait and watch to see whether a repo rate of around 6% is sufficient to glide inflation back to target,” Varma was cited as saying in the minutes. Tightening without a reality check could run the risk of overshooting the repo rate needed to achieve price stability, he added.
Central bank insiders on the MPC, meanwhile, cautioned about the second-order effects if pricing shocks persist or recur. “The RBI’s forward looking surveys suggest that selling prices in manufacturing and services may rise further as pass-through from input cost pressures remains incomplete,” said RBI deputy governor Michael Patra. “Taken together with a closing output gap, rising capacity utilisation in manufacturing, surging demand for services and the pick-up in spending as the festival season nears, monetary policy must move to red alert.”
