The latest decision by the Reserve Bank of India’s Monetary Policy Committee (MPC) to leave its policy rate unchanged is a calculated risk taken by the rate setting panel, especially when viewed in light of the upward revision of its inflation forecast. Barely two months after projecting Consumer Price Index-based inflation to average 5.1% over the current fiscal year ending in March 2024, the MPC has raised its forecast for the annual average by 30 basis points to 5.4%. Conceding that a spike in tomato prices had contributed to a shock that had forced a revision in the headline inflation projection for the July-September quarter by a ‘substantial’ 100 basis points to 6.2%, RBI Governor Shaktikanta Das acknowledged that while the likely short-term nature of these shocks allowed for policymakers to look past a couple of high inflation prints, frequently recurring food price shocks risk destabilising inflation expectations. And while monetary authorities are right in laying the onus on the government for ensuring timely supply side interventions to ‘limit the severity and duration of such shocks’, a broader unmooring of price stability will undermine macroeconomic stability and growth. Underlining its commitment to aligning inflation to the target of 4% and keeping inflation expectations anchored, the MPC reiterated, by a majority, its policy stance of staying focused on the withdrawal of accommodation.
In a nod to the MPC’s stance, the RBI, separately, temporarily imposed an incremental 10% increase in the cash reserve ratio banks must maintain, with a view to draining some of the surplus liquidity in the banking system that could spur prices. Mr. Das promised this increase would be reviewed on September 8 or earlier, to ensure adequate liquidity during the upcoming festival season. Still, given the MPC’s sanguine outlook on economic growth, it has not only retained its forecast for the GDP to expand by 6.5% in real terms in 2023-24 but also stuck by its June projections for growth in each of the four quarters, the inflation shock notwithstanding. To be sure, the MPC has flagged several risks to the inflation outlook: the uneven rainfall distribution this year, the recent uptick in crude oil prices (the average price of the Indian basket has so far risen by 7% sequentially this quarter), and enterprises polled by the RBI expect output prices to harden. And while Mr. Das and his colleagues on the MPC have reaffirmed their readiness to take policy actions in order to align inflation to the target and ensure that inflation expectations remain well anchored, how quickly policymakers actually walk the talk and intercede in the coming months will determine their inflation-fighting mettle.
