All six members of India’s monetary policy committee agreed that interest rates needed to be increased to counter oil-driven price pressures and expectations of higher inflation in the future, show minutes of the June 6 meeting. The committee had voted unanimously to hike the benchmark repo rate by 25 basis points to 6.25 percent at the meet. This was the first rate hike in over four years.
While there was consensus that the time for a rate hike had come, there was also agreement among most members that the uncertain global and domestic environment justified a neutral stance. This would allow the committee to respond to emerging growth and inflation dynamics.
Oil – a key risk to inflation cited in the MPC’s April 2018 resolution has since materialised, said RBI Governor Urjit Patel in his statement included in the minutes. He added that inflation expectations have also risen significantly. “Looking ahead, projected inflation for Q4 2018-19 (at 4.7 percent) is 30 bps higher than that in the April resolution,” Patel said.
In its June 6 statement, the MPC had said that retail inflation is expected at 4.8-4.9 percent in the first half of the year and at 4.7 percent in the second half of the year.
Growth, meanwhile, has strengthened to a seven-quarter high and appears to be on a sustainable path. Investment activity, in particular, has accelerated, Patel added.
I, therefore, vote for an increase in the policy repo rate by 25 basis points. In view of prevailing uncertainties, it is apposite to maintain the neutral stance so as to respond to the evolving situation in a flexible manner.Urjit Patel, Governor, RBI
Most members of the committee shared Patel’s view.
Ravindra Dholakia, who has so far been the most dovish member on the committee, acknowledged that inflation pressures have firmed up. He cited an increase in both inflation expectations of consumers and businesses.
An RBI survey, released soon after the policy review, had shown a significant increase in inflation expectations of about 90 bps and 130 bps respectively for the three-months and the 12-months ahead period. In addition, Dholakia cited the IIM Ahmedabad survey of businesses. The April 2018 round of the survey, shows a substantial increase of about 60 bps in the expectation of headline CPI inflation 12 months from now.
While expressing discomfort on inflation, Dholakia, like other members, expressed greater comfort on growth.
Capacity utilisation has increased substantially as revealed by different surveys. Growth in capital formation has also picked up. GDP growth at 7.7 percent for 2017-18 Q4 assures that the Indian economy is firmly on the recovery path. All this indicates that the output gap has started closing.Ravindra Dholakia, Member, MPC
Precise data on the level of capacity utilisation is yet to be released by the RBI.
Michael Patra, who has been voting for a hike in rates since February, said that there was now urgency to respond to rising inflation pressures. “The prolonged period of staying on hold is denting the credibility of the MPC's commitment to maintaining inflation at the centre of the target band,” said Patra.
Patra has been calling for a hike in interest rates as he felt that upside risks to inflation were ‘crystallising’. He also argued that markets and financial institutions are already ‘ahead of the curve’. The benchmark 10-year bond yield has risen significantly since last September in anticipation of higher rates and increased government borrowings. Banks also raised lending rates marginally even before the MPC did.
Patra cautioned that any further delay in raising rates would damage the credibility of the nascent inflation-targeting framework. The framework requires the committee to maintain inflation in a band of 4 (+/- 2) percent.
There is a rising risk that the public may start discounting this commitment: if it begins to believe that the MPC is willing to tolerate inflation in higher reaches, inflation expectations can be set adrift.Michael Patra, Executive Director, RBI
Explaining The Neutral Stance
While hiking rates, the MPC had maintained a neutral policy stance. This, according to Patel, is not contradictory as it allows the committee to move in either direction.
The MPC minutes show that most members were cautious on risks that emerge globally and domestically. This necessitated a neutral policy stance.
RBI Deputy Governor Viral Acharya cited uncertainties around oil and food prices on the inflation front to support his vote for a neutral stance. He also cited the uncertain fallout of trade wars and global financial market conditions in support of the stance.
“It [the neutral stance] will allow the MPC to determine in a flexible manner what further monetary policy response is warranted based on an ongoing assessment of the inflation situation, inflation expectations and growth prints in the coming month,” said Acharya.
The neutral stance retained by the MPC had led economists to forecast a short rate hiking cycle for now. Most economists, in views shared after the MPC meet, had said that they expect one or, at most, two more rate hikes this year.
The minutes support that view.
Chetan Ghate said that the evolving growth-inflation dynamics warranted ‘small steps’ for now.
The combination of cost-push and demand-pull factors at the current juncture has put one-year ahead inflation projections significantly above 4 percent. This warrants a monetary policy response. However, because of uncertainty surrounding the price of oil, and the nascent recovery of the economy, it would be opportune to take small steps.Chetan Ghate, Member, MPC
The MPC minutes suggests that the June rate hike did not mark the start of “meaningful tightening cycle”, said Nomura Global Market Research in a note. Further rate hikes will remain dependent on oil prices, among other factors, Nomura said. The brokerage house, though, expects the MPC to front-load its rate hikes by increasing rates by another 25 basis points in August, before voting to pause.