Amid growing uncertainties over the global macroeconomic outlook and private consumption on the domestic front, continued policy support is warranted for a durable, broad-based and self-sustaining rebound, Reserve Bank of India (RBI) governor Shaktikanta Das wrote in the minutes to the December monetary policy meeting. The minutes were released on Wednesday.
“In this scenario, it would be prudent to watch out for growth signals becoming well entrenched while remaining vigilant on inflation dynamics,” Das wrote, adding that there is also a necessity to have a firm understanding of the impact of the Omicron variant.
The calibration and timing of a monetary policy response and preventing build-up of financial stability risks are very important in such an uncertain environment, the governor said. He voted in favour of continuing with the accommodative stance.
According to deputy governor Michael Patra, inflation in India will peak in the last quarter of this year and from there, it will moderate. Patra observed that India’s inflation developments reflect a scissor effect – rebound in demand colliding with supply bottlenecks. However, shipping delays, delivery lags and semiconductor shortages cannot last indefinitely and should improve in the second half of 2022, he added.
“The surge of pent-up demand should also normalise by then. Accordingly, elevated levels of inflation will persist till then, whether we like it or not, but not longer,” Patra said.
Retail inflation based on the Consumer Price Index (CPI) increased to a three-month high of 4.91% in November as the impact of rising food prices outweighed cuts in duties and levies on fuel by the Centre and states. The monetary policy committee (MPC) attributed the flare-up in vegetable prices to heavy rains in October and November, and expects it to reverse with the winter arrivals.
The key question before the MPC is whether the economy can entail the output sacrifice arising out of tighter monetary policy at a time when the recovery is nascent, said RBI executive director Mridul Saggar. He also referred to supply-related disruptions and said it is best not to risk strengthening stagflationary impulses born out of such disruptions.
“Small moves towards policy normalisation may be sufficient now and one can decide to shift to a tightening monetary policy cycle at a point when it is clear that demand revival has acquired resilience and pandemic risks to growth have diminished or alternatively if inflation diffusion persists in near months which then can result in inflation getting generalised and persist next year, especially if inflation expectations get unanchored,” Saggar wrote in his statement.
Some market participants have seen the central bank’s decision to absorb liquidity mainly through variable rate reverse repo (VRRR) auctions from January 1 as a move to tighten policy by stealth. The announcement has resulted in short-term rates inching up even as the reverse repo rate remains unchanged.
External member Jayanth R Varma argued that there is increasing evidence of inflation becoming persistent in the upper region of the tolerance band, even though it is projected to remain within the band. Dissenting against retaining the accommodative stance, Varma wrote, “In this environment, it is no longer appropriate to stick to the monetary policy stance first adopted in May 2020 when the adverse economic effects of the pandemic were at their peak.”
Varma reiterated his case for raising the reverse repo rate from its current level of 3.35%. Raising effective money market rates quickly towards 4% would demonstrate the MPC’s commitment to the inflation target, help anchor expectations, reduce risk premia, enhance macroeconomic stability, and allow lower long-term interest rates to be sustained for longer, he added.