Easing retail inflation validates MPC stance, what next?

The decline in July retail inflation print to below the upper tolerance band of the Reserve Bank of India's monetary policy committee (MPC) has offered some comfort to the rate-setting panel. If the decline sustains and growth picks up, it can offer room for gradual policy normalisation, economists have said.

“We anticipate that the MPC will embark on policy normalisation once domestic demand strengthens and starts dominating inflationary pressures in place of supply-side issues,” said Aditi Nayar, Chief Economist, ICRA.

On August 12, official data showed that the Consumer Price Index-based inflation (CPI) for July fell to 5.59 percent from 6.26 percent in June.

“We foresee a change in the stance to neutral from accommodative in the February 2022 policy review followed by a hike in the repo rate of 25 bps each in the April 2022 and June 2022 reviews,” Nayar said. The MPC may go for a staggered rate increases over a period of time instead of immediately trying to push real interest rates back into the positive territory, she said.

Similarly, CARE rating said the retail inflation is likely to remain within the RBI’s target range in the coming months also helped by easing of movement restrictions. However, elevated global crude oil prices could strengthen the underlying core pressures, CARE said.

“We expect the CPI numbers in the next two months to remain close to the upper band of the RBI’s target range, around 5.5-6 percent despite the high statistical base,” CARE said.

In its August policy review, the MPC reiterated its "accommodative stance" as long as necessary to revive growth and decided to overlook the inflation spike.

Also read: Banking Central | How long can MPC ignore inflation and remain 'accommodative'

Inflation eases

Easing food prices helped bring down the CPI inflation in July to 5.59 percent from 6.26 percent in the previous month, back within MPC's range of 2-6 percent.

In May, CPI inflation was at 6.3 percent. In the August 6 monetary policy statement, the MPC said that its current assessment shows “the inflationary pressures during Q1:2021-22 are largely driven by adverse supply shocks which are expected to be transitory.” In that sense, the July inflation print shows the MPC assessment was correct.

In his address, the RBI Governor Shkatikanta Das, too, said that the inflation spike was transitory. “The available data point to exogenous and largely temporary supply shocks driving the inflation process, validating the MPC’s decision to look through it,” Das said.

“The supply-side drivers could be transitory while demand-pull pressures remain inert, given the slack in the economy. A pre-emptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions,” Das said.

The easing of inflation in July validates the argument.

In the August review, the MPC retained the key lending repo rate, for the seventh consecutive time at 4 percent and continued with the so-called accommodative stance. An accommodative stance indicates the willingness to either cut rates or stay on hold while a rate hike is ruled out.

The RBI hiked the CPI inflation estimate for the fiscal year 2022 to 5.7 percent from 5.1 percent.

Of the six MPC members, five voted in favour of the continuation of the accommodative stance, while Jayanth Varma voted against it. The minutes of the MPC meeting will be released on August 20.