RBI's Monetary Policy: Rate hike or no hike, inflation continues to be a headache for Shaktikanta Das

It is not so much the concerns about growth or the dangers to financial stability post the global banking crisis, but rather persistent inflation that is becoming a major headache for the Reserve Bank of India (RBI) Governor Shaktikanta Das as he, along with the other members of the Monetary Policy Committee (MPC), looks to decide on interest rates tomorrow.

Despite some softening in the headline number, there has been no clear trend towards a sustained fall in the retail inflation or Consumer Price Index (CPI) basket.

There is a consensus in the market that the MPC will go for one more repo rate hike of 25 basis points to 6.75 per cent and then there will be a pause. But the way the inflation trajectory is panning out, there could be more hikes. But there is also another camp that says the full transmission of rate hikes hasn't happened yet and RBI should wait and watch before making more hikes in the benchmark rates.

Two MPC members -- Ashima Goyal, professor at the Indira Gandhi Institute of Development Research and Professor Jayant R. Varma, professor at the Indian Institute of Management Ahmedabad -- are already rooting for prioritising growth.

An analysis of the CPI index for the month of February reveals that 10 out of 25 items in the inflation basket have a year-on-year (YoY) rate of over 6 per cent, which exceeds the RBI's upper band. The RBI has a mandate to keep the inflation below 6 per cent with a target of 4 per cent with +-2 per cent.

These items with a 6 per cent YoY inflation rate include cereals, milk, fruits, prepaid meals, clothing, footwear, household goods, healthcare, and personal care. The increase in cereal prices is very sticky after the Russia-Ukraine conflict. Similarly, the milk prices are going up because of the increase in fodder prices.

Dr. Shashanka Bhide, one of the MPC members, has also highlighted this fact in the February policy, that sustained moderation in headline inflation can only be expected when most major components of the index fall below the 6 per cent mark.

Before putting brakes on rate hikes, it's clear that the RBI will pay close attention to a long-term trend of falling inflation.

Since May last year, the benchmark repo rate has already been increased by 250 basis points to 6.50 per cent.

Governor Shaktikanta Das said in the February policy that the RBI needs a clear slowdown in inflation. The RBI at that time had CPI data up to December 2022. The headline CPI inflation rate actually decreased during November and December from its level of 6.8 per cent in October 2022 by 105 basis points. Yet, when the January and February 2023 CPI numbers were made public, retail inflation surged above the 6 per cent mark. "That came as a surprise," a market player told BT.

The annual inflation forecast for 2023-24 remains high at 5.3 per cent, with the CPI ending 2022-23 at 6.5 per cent. These projections for 2023-24 are based on a crude oil price (Indian basket) of $95 per barrel and a normal monsoon. However, the price of crude oil is also set to go up again because Russia is producing less and China is buying more. OPEC has also decided to cut production.

HSBC Global said in its report that improving growth prospects in the informal sector have kept inflation elevated. Manufacturers are taking this opportunity to raise prices and restore margins, keeping core inflation high. And then there's food inflation. "Base effects will turn favourable March onwards, yet trajectory will also be dictated by weather conditions," said Radhika Rao, Executive Director & Senior Economist at DBS Group Research, in her note.

The RBI's main job is to keep prices stable, and it can't afford to be casual about this important mandate. The RBI had already missed its inflation goal in the past for three quarters in a row. Now to keep its credibility intact, it needs to fix this problem first.

There are two other issues that are bothering the global central bankers, which are financial stability and growth concerns. But for the RBI, there is no risk to financial stability as interest rates have only been increased by 250 basis points, which is half of what the US Federal Reserve has done. Additionally, the credit portfolio dominates the Indian banking system, with most banks' income coming from interest and non-interest sources rather than treasury income. There is no threat of mark to market losses in the Indian banks' investment portfolio.

Second, there are also no heightened growth concerns. The credit growth situation in the economy is improving after being in single digits for a long time. The banks' balance sheet is also clean, with comfortable capital adequacy ratios. The high frequency indicator, like GST collections, has increased by 22 per cent in 2022-23 as compared to the previous year.

While exports have declined, India is not heavily reliant on exports like China, Brazil, or Russia.

The capacity utilisation remains at 75-80 per cent, and the Union Budget for 2023-24 has increased capital expenditure, which will push the growth in the medium to long term.

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