Inflation posing the 'last mile' challenge

The MPC noted that domestic economic activity is holding up well while large and repetitive food price shocks are interrupting the pace of disinflation.

The monetary policy review of February 8 reminds me of a famous quote by SS Tarapore, a former Deputy Governor of RBI and a well-known crusader against inflation. He had said in one of his interviews in the mid-1990s: “Those countries which have taken care of their fiscal deficits, sustained current account deficits, and reined in inflation have moved with less capital controls and succeeded. Those countries which do not give adequate attention to strengthening these conditions have paid a heavy price.”

The recently announced interim budget, the evolving trajectory of Current Account Deficit (CAD) and the RBI’s actively disinflationary monetary policy even though core inflation has fallen below 4 percent, do suggest that India is well placed in terms of macro-financial stability.

Positive On Growth, Caution On Inflation

In today’s policy review, the Monetary Policy Committee (MPC) noted that domestic economic activity is holding up well while large and repetitive food price shocks are interrupting the pace of disinflation. Even though core inflation has significantly moderated, India cannot ignore transitory spikes in food and fuel inflation, given their likely spillover into higher core inflation, if they are persistent. The proximate risks to India’s food inflation come from cereals, pulses, sugar and spices. The MPC has acknowledged that adverse weather events remain the primary risk with implications for the rabi output. Also, increasing geopolitical tensions are leading to supply chain disruptions and price volatility in key commodities, particularly crude oil.

Against the backdrop of the current growth-inflation mix, and incomplete policy transmission (especially on the outstanding loans & deposits), the MPC decided by a 5 to 1 majority to keep the policy repo rate unchanged at 6.5 percent and to remain focused on ‘withdrawal of accommodation’ to reach the inflation target of 4 percent on a durable basis. It has been reiterated that the MPC will remain resolute in this commitment.

Led by the improved investment intentions of the private corporate sector and steadily improving demand conditions (especially in urban areas), the MPC has projected real GDP growth for FY25 at 7 percent (7.2 percent in Q1, 6.8 percent in Q2, 7.0 percent in Q3 & 6.9 percent in Q4 of FY25). For inflation, the MPC has highlighted that its trajectory would be shaped by the evolving food inflation outlook. Assuming a normal monsoon next year and considering the disinflationary effect of the ongoing tightening, the MPC has projected CPI inflation for FY25 at 4.5 percent (5.0 percent in Q1, 4 percent in Q2, 4.6 percent in Q3 & 4.7 percent in Q4 of FY25).

Guidance On Liquidity

In today’s policy, market participants were keenly looking for the RBI’s futuristic guidance on ‘liquidity,’ as the system level liquidity turned into deficit from September after a gap of four and half years. According to RBI, the system level liquidity deficit widened from an average of Rs 0.42 trillion during September-November to Rs 1.61 trillion during December-January of FY24.

As the Government is in a fiscal consolidation mode, it has been restraining ‘spending’ in a major way. According to the Governor’s statement, ‘potential liquidity’ in the banking system is still in surplus after adjusting for the Government’s cash balances. In fact, a pick up in the Government spending towards the end of January, prompted the RBI to undertake six variable-rate reverse repo auctions in the first week of February to absorb surplus liquidity.

As long as the policy stance remains at ‘withdrawal of accommodation,’ the RBI will deploy various instruments to avoid ‘liquidity overhang’ in the system so that the weighted average call money rate remains closer to the repo rate of 6.5 percent.

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The RBI has expressed confidence about the improving financial health of both banks and NBFCs. In particular, the NBFC sector’s resilience has improved with CRAR at 27.6 percent, GNPA ratio at 4.1 percent and return on assets (RoA) at 2.9 percent, respectively in September 2023.

Focus On Bolstering Financial System

The RBI has also taken a few developmental/regulatory measures to improve the safety and stability of the financial system.

• The RBI has decided to undertake a review of the regulatory framework for electronic trading platforms (ETPs) to enable market-makers access offshore ETPs offering permitted Indian rupee products.
• It has allowed hedging of gold price risk in the OTC market in the International Financial Services Centre. This gives more flexibility in terms of platform and timing to retailers and institutions to efficiently hedge their positions without the help of commodity exchanges and even outside the timing of exchange.
• It has asked all regulated entities to provide a “Key Fact Statement” (which includes annualised all-inclusive interest rates) to borrowers of retail and MSME loans for greater transparency and disclosure. This will make “terms & conditions” transparent to all types of borrowers. Currently this is applicable to individual borrowers, digital lending by regulated entities and micro loans.
• It has proposed that onboarding of Aadhaar-enabled Payment System (AePS) service providers will be streamlined and additional fraud prevention measures be introduced. The AePS is a bank-led model that allows online financial transactions at Point-of-Sale (PoS) and Micro ATMs through the business correspondent of any bank using Aadhaar authentication. It removes the need for OTPs, bank account details, and other financial details.
• It has also proposed to introduce a principle-based framework for the authentication of digital transactions to enhance the security of such transactions.
• It has introduced the programmability and offline functionality in its digital currency pilot to facilitate transactions for specific purposes and in areas with poor connectivity.