The monetary policy committee (MPC) opted for an out-of-cycle repo rate hike so as not to miss its inflation target in two consecutive quarters and be compelled to go for bigger raises at its June and August meetings, according to people in the know.
Sources said the MPC’s hand was forced by three developments that transpired after the April policy meeting. The first was the March consumer price index (CPI) reading of 6.95%, which came in higher than expectations of most forecasters. The second was a firm and rising trend in consumer prices sourced from the Department of Consumer Affairs, mandis and e-commerce platforms, which suggested a further inch-up in food prices in April. The third was the decision by Indonesia to ban palm oil exports, which would further hit edible oil prices in India.
“These developments raised doubts in the MPC’s mind that they were going to face problems in the second consecutive quarter. Hence, it was important to get enough time to space out the policy actions. If they had not done the off-cycle meeting, they would have only two meetings to react – June and August,” a source close to the developments said.
The MPC overshot the upper end of its inflation target band of 2-6% in the January-March quarter.
If the out-of-turn meeting and the 40-basis point (bps)-hike had not taken place, the June policy would have seen a much steeper 115-200 bps hike just to reach the pre-pandemic levels, the person said. “So the off-cycle meeting is intended to smooth it out and make small increases instead of large increases,” the source said.
The central bank remains open to the possibility of holding rates in case the April inflation print is well within the MPC’s target band of 2-6%.
In its last two policy statements, the MPC has characterised the easy money policy of the last two years as pandemic-era ultra accommodation, which now needs to be withdrawn. The MPC is believed to have taken a decision on rate hikes after seeing little action on the fiscal policy front to ease supply chain issues that are exacerbating the inflation problem.
At the same time, the RBI is coming round to the view that sustained high inflation could hurt demand conditions as well.
In his May 4 statement, RBI governor Shaktikanta Das said that persistently high inflation has pronounced adverse effects on the poorer segments of the population by eroding their purchasing power. Earlier, in the minutes to the April policy meeting, deputy governor Michael Patra had written that irrespective of whether supply bottlenecks are the driver or pent-up demand, it will become more difficult to tame inflation the longer the fight is delayed.