MPC members batted for front loading of rate hikes, show minutes

Members of the Monetary Policy Committee (MPC) strongly pitched for frontloading rate hikes to quell inflationary pressures in the economy, according to the minutes of the panel's August meeting released on August 19.

“Although inflation seems to have peaked, it is still unconscionably high," Deputy Governor Michael Patra said in the minutes. "Risks to the trajectory of inflation in the form of currency depreciation, seasonal pressures and the monsoon’s uneven progress could upend the moderation in momentum recently recorded."

Patra added that even with perfect credibility, monetary policy cannot look through the second-round effects of repeated supply shocks. The inflation target may be breached for a prolonged period, he added. This could unsettle expectations and eventually get reflected in higher inflation.

Also read: MPC resolution to remain focused on withdrawal of accommodation confusing: Jayanth Varma

Data released on August 12 showed India's headline retail inflation rate, as measured by the Consumer Price Index (CPI), fell to a five-month low of 6.71 percent in July. However, it has now spent 34 consecutive months above the Reserve Bank of India's (RBI) medium-term target of 4 percent and seven straight months outside the central bank's 2-6 percent tolerance range.

As such, the central bank is only two months away from failing to meet its inflation mandate, which is deemed to occur when average inflation is outside the 2-6 percent tolerance range for three consecutive quarters.

The MPC has hiked the repo rate by a total of 140 basis points over the last three-and-a-half months to quell inflationary pressures in the economy. In the August policy, the MPC hiked the repo rate by 50 bps. One bps equals one hundredth of a percentage point. Economists expect the MPC to slow the pace of hikes in the next couple of meetings.

According to Patra, a delay in the monetary policy response to repeated unfavourable supply shocks leads to a further loss of credibility, unhinging of inflation expectations and eventually, higher inflation outcomes with a higher sacrifice of growth. Frontloading of monetary policy actions can keep inflation expectations firmly anchored, re-align inflation with the target and reduce the medium-term growth sacrifice as it is timed into the recovery underway, he added.

RBI Governor Shaktikanta Das, the head of the six-member MPC, also had similar views. Das said that sustained high inflation, unless addressed effectively, could result in un-anchoring of inflation expectations and their second order effects. This necessitates appropriate monetary policy response to prevent upward drift in inflation from the target rate, Das said.

Das added that the MPC will continue with ‘whatever it takes’ approach, given the new set of challenges and very high uncertainties that it is confronted with. The sequence of the MPC’s policy measures is expected to strengthen monetary policy credibility and anchor inflation expectations, he said.

Inflation ‘unacceptably’ high:

External member Jayanth Varma also expressed his concerns over rising price pressures, stating that inflation is “unacceptably” high. Varma said that he was caught between 50, 60 and 75 basis points rate hike. However, in the context of market expectations of a 35-50 basis point hike, risks of a large hike could be misinterpreted as a sign of panic, and could be unnecessarily disruptive, noted Varma, explaining why he did not favour a 60 or 75 basis point hike at this juncture.

Arguing against the MPC’s resolution of “withdrawal of accommodation,” Varma said that the statement “confuses more than it clarifies.” It can only mean withdrawal of the pre-pandemic accommodation that began with the rate cut from 6.50 percent to 6.25 percent in February 2019, he said. Such an indication of a terminal repo rate of 6.50 percent is totally unwarranted, Varma added.

“At this meeting, I suggested that this resolution should simply be dropped. It is better not to give any guidance than to give confusing guidance,” Varma said. “Unfortunately, none of these proposals found favour with the other members.”

However, another member Ashima Goyal voted for ‘withdrawal of accommodation’ to continue, since such a stance defined in terms of liquidity also indicates that durable liquidity will continue to be in surplus. This reassurance is important in a period of risk-off and possible outflows as the Fed continues its quantitative tightening, Goyal said. The Liquidity Adjustment Framework (LAF) system has enough instruments to sterilize any effect on domestic liquidity, she added.

Goyal also noted that the interest differential with the US has only a minor and possibly perverse effect on capital flows. A rise in Indian interest rates will not induce equity investment, which is the one that is currently volatile, to stay, she added.

Shashanka Bhide said that the upside risks to any declining inflation trajectory in the short term are significant.” Sustaining the growth momentum will also require reduction in inflation rate.

Another member Rajiv Ranjan said that frontloading of policy actions are expected to strengthen monetary policy credibility and temper the need for aggressive rate hikes in future.