The crux of the policy can be highlighted by the following quotes. First, the RBI expects the decisions outcome will help maintain the credibility of the commitment of monetary policy to controlling inflation and in the absence of complementary policy response on both the demand and supply sides, strong monetary policy actions are required. Thus, the RBI seems to be a tad worried that its credibility in controlling inflation could be weakening as the headline WPI inflation continues to surprise on the higher side. In FY2011, the RBI had to revise its March 2011 WPI projection three times, first from 5.5% to 7.0% and further to 8.0% and it finally printed at 9.68%. In this policy too, RBI has moved up inflation forecast for end-March 2012 now to 7.0% from 6.0% . The onus of engineering a demand compression lies on the RBI, since the fiscal policy has and is likely to remain supportive of domestic demand.
But, despite the 11 rate hikes by the RBI in the last 16 months and by a cumulative 475bps in the effective rate and where the transmission of monetary policy has been smoother than in the previous occasions, the risk to inflation surprising on the higher side continues. The global dynamics could be looking at a weaker growth trajectory, but unfortunately this might not translate into softer commodity prices as more money could be thrown at the problem. Further, domestically, inflation pressures could remain high on account of inertial dynamics of wage and food prices.
Purchasing power of the poor has also not been dented by inflation as NSSO indicates a rise in the real wages of the casual labourers.
Also, MGNREGA wages are being indexed to inflation and this in turn leads to increases in the wage bargaining capacity in the causal labour market. This, wage-price inertial movement could, according to the RBI, add to the structural pressure on food inflation.
There was an acknowledgement that growth is moderating, but mostly restricted to certain interest rate sensitive sectors rather than being broad-based. Consumption demand, according to RBI has moderated but not adequately. And, thus in its efforts to break the back of inflation, RBI appears to be comfortable with growth deviating slightly on the downside from its stated projections of 8.0% and would only move away from its current anti-inflationary bias only once inflation shows a sustainable downturn.
Finally, given my own understanding of inflation peaking around August-September without further revisions in domestic fuel prices, I anticipate there could be 50 bps more of upward adjustment in the Repo rate in two equal doses.
Writer is chief economist with Kotak Mahindra Bank