The art of letting it be

General Studies Paper 3

RECENT CONTEXT

• Recently, Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) maintained the status quo on interest rates during its review meeting and retained its stance of withdrawing accommodation.
• The RBI prefers higher rates for longer periods for both domestic and external reasons.

Domestic reasons for upholding higher rates

• Food based inflation: As in the beginning of the second quarter of this fiscal year prices of tomatoes and other food items rised significantly and then it became more concerning with volatile and rising crude oil prices.
• The RBI Governor also noted that the transmission of past rate hikes — 250 basis points since May 2022 — to bank lending and deposit rates remains incomplete.
• These factors have nudged the MPC to hold its stance of “withdrawal of accommodation

External reasons: Hawkish policy of major central banks of other nations

• The continuation of hawkish monetary policies by systemically important central banks, particularly by the US Federal Reserve, and the rise in crude oil prices have been external triggers.
• Global central banks have been on their toes since Covid-19 struck.
• First, they had to ease monetary policy rapidly to fight an economic collapse, and then hike repeatedly to tame inflation.
• For instance, policy rates have risen only 250 basis points in India in the current cycle compared with 525 basis points in the US.
• Central banks in the advanced countries could likely err on the side of caution and keep rates higher for longer given the challenges in inflation control.
• The upshot of this stance is the US 10-year treasury yield soaring to 4.8 per cent, the highest in 16 years.
• This is attracting capital to the US and away from the emerging markets, and strengthening the dollar. The rupee, not surprisingly, has been under the pump.
• To its credit, India’s growth has held strong despite costlier crude oil, weakening rupee and pressure on food inflation from an erratic monsoon. Supply shocks amid healthy growth will keep the RBI cautious.
• It has already raised its inflation forecast for this fiscal to 5.4 per cent from the 5.2 per cent made in June.

India’s policy to maintain growth with targeted inflation

• India’s growth has held strong despite costlier crude oil, weakening rupee and pressure on food inflation from an erratic monsoon.
• Supply shocks amid healthy growth will keep the RBI cautious. It has already raised its inflation forecast for this fiscal to 5.4 per cent from the 5.2 per cent made in June.
• Recently, fresh arrival of vegetables in the market have corrected vegetable prices, and crushed those of tomatoes, causing angst at farms.
• RBI’s inflation for the second quarter at 6.4 per cent implicitly assumes around 5 per cent inflation in September

Challenges ahead in controlling inflation

• The concern over cereals, pulses and spices inflation persists given their double-digit readings.
• To boot, overall kharif sowing is only marginally above last fiscal’s level and lags for pulses and jute.
• With El Niño conditions predicted till year-end, is also alarming.
• The southwest monsoon also influences groundwater and reservoir levels for the rabi or winter crop, which is produced in largely irrigated areas.
• According to the Central Water Commission, as on September 29, live storage at reservoirs was 82 per cent of the previous year’s corresponding levels and 92 per cent of the decadal average.
• New hike in crude oil prices have emerged as another potential risk. India is highly vulnerable here because around 85 per cent of its requirement is imported. Crude prices have been very volatile
• If they rise and sustain at elevated levels, headline inflation can rise via direct and indirect effects of higher production and transportation costs.
• In addition, higher crude prices create upside risks for the current account and fiscal deficit, and a downside risk to growth

Conclusion

• The RBI has retained its GDP growth outlook at 6.5 per cent for this fiscal. Deepening global slowdown curbing exports, lagged impact of the series of domestic rate hikes manifesting and curbing consumption demand, and erratic weather and El Niño curbing agricultural growth.

What’s more, persistent supply shocks, whether from food or fuel, can transmit to other parts of the economy and broadbase inflationary pressures. Ergo, the MPC is unlikely to take the scalpel to rates soon.