Monetary Policy: RBI Explains Its Approach To Post-Pandemic Inflation And Growth

India's Monetary Policy Committee kept interest rates unchanged for the seventh straight meeting. Judging inflation as "exogenous" and "largely temporary" and growth as "nascent" and "tentative", Reserve Bank of India Governor Shaktikanta Das said an accommodative monetary policy is appropriate.

But inflation, now projected to average 5.7% in FY22, is higher than the mid-point of the MPC's target of 4 (+/-2)%. How soon will the central bank return to a focus on inflation?

RBI Deputy Governor Michael Patra offered clarity.

"If we step back a little bit, things will get a little more clear," Patra said. He explained that between 2016 and 2020, CPI inflation was close to 4%. In 2021, he said, the pandemic led to higher margins, taxes were raised and there were supply disruptions.

Inflation went up to 6.2% on an average. "Now we are looking at average inflation of 5.7%, an improvement over 2021," he said.

"So, the path of inflation is being calibrated downwards on the way to reach 4%," Patra said. From 6.2% in a pandemic year to 5.7% following the year, and thereafter to 4% is the right way to go, he added.

"The approach to inflation is not a cold turkey method, where you slam the economy until it goes limp," Patra said. "It is important to bring that down over time and not immediately."

Headline CPI inflation plateaued at 6.3% in June after having risen by 207 basis points in May 2021, according to the MPC resolution. "Already we have seen the prices of pulses and edible oils declining," Patra said. All these will go into inflation and help steady the process, he said.

Inflation will remain close to the upper tolerance band up to the second quarter of FY22, but these pressures should ebb in the third quarter on account of kharif harvest arrivals and as supply-side measures take effect, RBI Governor Das had said in his speech earlier. "A preemptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions," he said.

What about growth? How is the RBI judging the strength of the recovery? When will the central bank be comfortable shifting its focus back to the core mandate of inflation?

Responding to a query by BloombergQuint, Patra also explained the central bank's approach to monitoring growth.

"We have looked at actual levels of a number of indicators," he said. "We compared these levels to what they would be during normal times. In the Indian industry, for instance, capacity utilisation of 75% indicates that the industry is close to full capacity. Likewise, order books and inventory and other such indicators are being studied."

One can also look at month-on-month seasonally adjusted annualised rates, Patra said.

While the central bank is looking at levels of economic activity in FY20, it is "acutely aware" that the pre-pandemic year was when a slowdown had already set on and growth was the lowest in the current series.

Still, the central bank is looking at these pre-pandemic levels to assess growth, Patra said. "We are not just taken away by base effects."

Driven by base effects, real GDP growth is projected at 9.5% in the current financial year. In the first quarter of the next year, growth is seen at 17.2%.