The Reserve Bank of India’s Monetary Policy Committee cautions about potential inflation risks due to food price shocks and weather fluctuations, emphasizing the need for sustained disinflation. The minutes of the MPC meet for the policy review in December show that members opted to maintain a disinflationary stance, keeping the policy repo rate at 6.50% to anchor inflation down to the 4% target. Despite global volatility, the Indian economy displays resilience, with an upwardly revised GDP growth projection of 7% for the current year. While global economic risks persist, including geopolitical conflicts, the RBI notes a reversal in trends such as decreased crude oil prices. Overall, the macroeconomic environment shows relative stability, with ongoing vigilance against potential slowdown risks.
Here’s what the members said during the review meeting:
Shaktikanta Das, RBI Governor
Moving forward, while food inflation has receded from the highs seen in July, it remains elevated. The overall inflation outlook is expected to be clouded by volatile and uncertain food prices and intermittent weather shocks. In the immediate months of November and December, a resurgence of vegetable price inflation is likely to push up food and headline inflation. We have to remain highly alert to any signs of generalisation of price impulses that may derail the ongoing process of disinflation.
Inflation is moderating, but we are still quite a distance away from our goal of reaching 4 per cent CPI on a durable basis. The projected inflation (4.7 per cent) in Q3 of next year, i.e., one year from now, is perilously close to 5 per cent. In these circumstances, monetary policy has to be actively disinflationary. Any shift in policy stance now would be premature and risky. Further, with past rate hikes still working through the economy, it would be desirable to closely monitor their full play out. The conditions ahead could be fickle and call for prudent evaluation of the emerging situation. Considering all the above factors, a pause in rate action and remaining focused on withdrawal of accommodation is considered necessary in this meeting of the MPC. Accordingly, I vote for keeping the policy repo rate unchanged and continuing with the focus on withdrawal of accommodation. We have to remain vigilant and ready to act effectively in our journey towards 4 per cent inflation target.
Headline inflation is expected to be within the tolerance band at 5.4% in FY24 and to fall to 4% in Q2 FY25 but rise to 4.7 in Q3. Core inflation shows a broad based moderation falling from 6.1 in 2022-23 to 4.8 in Q2 FY24. Professional forecaster’s figure for core inflation in Q3 is at 4.4%.
There is a view that stronger growth will raise core inflation. But even with real GDP growth at 7% it does not necessarily imply potential output is reached implying excess demand and pressures on core inflation if reforms are raising structural growth.
The challenge for monetary policy is to facilitate this benign outcome where inflation trends down and growth remains robust.
This requires two things. First, a restrictive monetary policy must be maintained long enough to glide inflation to its target of 4%. Second, as inflation drops well below the upper tolerance band, it is necessary to prevent the real interest rate from becoming excessive. At present, projected inflation two to four quarters ahead averages below 4.75%. The prevailing money market interest rates of 6.75% (close to the MSF rate) therefore represent a real interest rate of more than 2%.
Going forward, core inflation pressure could remain muted, as our monetary policy actions play out and softer growth in input costs and selling prices of the manufacturing sector keep price pressures contained. Concerns on elevated food inflation, however, is a major source of uncertainty for the inflation outlook.
Given that inflation remains above target, our stance of withdrawal of accommodation also has to continue to aid fuller transmission. Having taken a pause during the last few policies, there could be an argument for a change in stance to neutral. I feel this is not the right time. Apart from being premature, a change to neutral stance may have to bear the brunt of the collateral damage caused by wrong signalling, particularly with looming uncertainties on the horizon and when market expectations are running ahead of policy intent.
The recent GDP data release reinforces the view that the output gap in India has turned positive since the beginning of the year and remains so. This points to the likelihood of demand pull shaping the course of inflation outcomes in the period ahead, amplifying future supply shocks. Over the rest of the year, rising momentum of activity will drive growth offset by waning of favourable base effects. Rural demand is gradually improving while urban demand remains ebullient. Investment has emerged as the mainstay of aggregate demand. It remains to be seen if the recent upturn in exports of merchandise sustains. The strength of underlying domestic demand is also being reflected in the pick-up in non-oil non-gold imports after a prolonged contraction.
Against this backdrop, the monetary policy reaction function needs to assign a higher weight to inflation relative to growth in a forward-looking sense.
While the core CPI inflation rate (excluding food and fuel components) fell below 5% in Q2: 2023-24 and dropped to 4.3% in October, price pressures in the non-farm sectors are vulnerable to shocks to input costs.
Inflation has moderated in the context of the continued pressure the cumulative monetary policy actions as well as supply side measures by the government in crucial consumption sectors have exerted. The weak external demand conditions have also meant favourable input prices in the international markets. However, food inflation is a concern in the short term. There remain significant risks of the impact of the on-going geopolitical conflicts on particularly fuel prices and consequently on both fuel and core inflation rates.