(Source: BloombergQuint)

MPC Minutes: With 4% Inflation Target In Sight, Committee Voted For A Second Rate Hike

Five of India’s six monetary policy committee members voted for a hike in rates at the policy review meeting earlier this month, but most believed that prevailing global and local uncertainties justified a neutral stance, showed minutes of the August meet released on Thursday. Ravindra Dholakia dissented and voted for a status quo, arguing that real rates in the economy are already too high.

The MPC raised the benchmark repo rate by 25 basis points to 6.5 percent on Aug. 1. This was the second rate hike in as many meetings.

Eye On 4 Percent Inflation

The MPC has been mandated with maintaining consumer price inflation within a band of 4 (+/- 2) percent. While it has met the objective of containing inflation within that range, it has not managed to bring down inflation to the mid-point of 4 percent in a durable fashion.

At least three MPC members, including RBI Governor Urjit Patel, cited that as one factor behind the vote for a rate hike.

I vote for an increase in the policy repo rate by 25 basis points; this action is a necessary step towards securing the mandated 4 percent inflation target on a durable basis. 
Urjit Patel, Governor, Reserve Bank of India

Patel, however, voted for a ‘neutral’ monetary policy stance in light of ‘several uncertainties that are present.’

Patel noted that actual inflation levels have been slightly below the RBI’s projections as food inflation has surprised to the downside. “The outlook for inflation, however, is faced with both upside and downside risks.”

The downside risks could emerge from the threat of tariff wars and the threat of financial market volatility, said RBI Deputy Governor Viral Acharya, but added that he is more concerned about the upside risks.

I vote to raise the policy rate by 25 basis points as a step towards fulfilling our inflation targeting mandate while paying attention to growth. The rate hike of June followed by another rate hike will help rein in demand pressures and manage inflation expectations.   
Viral Acharya, Deputy Governor, RBI

RBI executive director Michael Patra joined his central bank colleagues in asserting that the MPC’s failure to meet the 4 percent target could dent the committee’s credibility.

“The risk of failing to achieve the inflation target, and of being perceived as willing to accommodate deviations over the remaining period for which the MPC is tasked, has increased significantly,” Patra said. This could unhinge inflation expectations and allow inflation outcomes to test the upper tolerance band, he added.

Patra, too, voted for a rate hike but did not detail his preferred monetary policy stance in the statement.

‘Real Rates Too High’

Ravindra Dholakia, the lone dissenter on the committee, voted for a pause in rates arguing that real rates are already too high.

According to Dholakia, the real policy rate for businesses is close to 2 percent, since their 12-month ahead inflation expectation is only 4.16 percent. These high real rates are already adversely impacting capital formation, Dholakia said.

This is certainly not the time and environment to hike the policy rate. Nor is it the time to tinker with the policy stance. Prudence lies in maintaining status quo on both.
Ravindra Dholakia, Member, MPC

Dholakia pointed out that actual inflation has been lower than RBI projections in May and June. This trend continued in July with CPI inflation falling more than estimated to 4.17 percent, compared to 4.9 percent in June. If this trend continues, the 12-month ahead inflation forecast could also be pared, he said.

Dholakia added that the concerns about high core inflation are not warranted as his research shows that core inflation will move down towards headline inflation, rather than the other way around.

A Pause Ahead?

Most economists expect the MPC to pause after two consecutive rate hikes. While the MPC members themselves do not give guidance, their statements reflected the conflicting pulls and pressures on growth and inflation.

Chetan Ghate highlighted the possible upside risks to inflation emerging from higher minimum support prices, even though he acknowledged that the actual impact will depend on the level of procurement.

Higher MSPs of this magnitude have the potential of pushing headline inflation sustainably and significantly beyond the 4 percent target for headline inflation mandated in the RBI Act.   
Chetan Ghate, Member, MPC

Ghate also noted the rise in inflation expectations for both the three-month and one-year ahead period. This “suggests that much work lies ahead in making monetary policy more credible and anchoring inflationary expectations,” Ghate said. He remained sanguine on near- and medium-term growth prospects.

While highlighting inflation concerns, committee member Pami Dua also noted the possible downside risks to growth. Dua flagged the drop in consumer outlook in the RBI’s latest survey and added that growth could also take a hit due to global tensions.

Downside risks to growth also include rising trade tensions that may hamper demand for India’s exports, aggravating the cyclical slowdown in exports signalled by the continued downswing in the growth rate of the Indian Leading Exports Index maintained by the Economic Cycle Research Institute, New York.
Pami Dua, Member, MPC