5 of 6 MPC members voted for status quo on repo rate

The six-member Monetary Policy Committee headed by RBI Governor Urjit Patel flagged inflationary impact of fiscal slippage, imminent increases in minimum support prices (MSPs) for kharif crops, and elevated commodity prices, especially of oil, to vote 5:1 in favour of maintaining status quo on repo rate.

Cost-push factors

As per the minutes of the Monetary Policy Committee meeting (held on February 6-7), released on Wednesday, Chetan Ghate, Professor, Indian Statistical Institute, who voted for a pause in the policy repo rate, said inflation, excluding food and fuel, may be increasing more because of cost-push factors, which will worsen the growth-inflation trade-off.

Ghate elaborated: “In my last review, I had flagged how increases in MSP by the government could lead to generalised inflation, and worsen monetary transmission, based on research (with co-authors).

“While details on the exact procurement policy are awaited, the enactment of a more elaborate procurement policy in the 2018-2019 Union Budget will put stress on State finances as well. Fiscal slippages in India are inflationary!”

In the sixth monetary policy review on February 7, the MPC chose to keep the repo rate (the interest rate at which banks borrow funds from the RBI to overcome short-term liquidity mismatches) at 6 per cent.

Risks remain

Referring to the upside risks to inflation and lacklustre growth prospects, Pami Dua, Director, Delhi School of Economics, said a wait-and-watch strategy with status quo in policy interest rate and a neutral stance is currently recommended.

Dua observed that going forward, several upside risks to inflation remain. These include the possibility of an increase in global commodity prices and higher crude oil prices. Fiscal deficit slippage and the slower than expected fiscal consolidation as well as the staggered impact of house rent allowance by State governments may also exert pressure on inflation. The proposal in the Budget to link the MSPs for kharif crops with 1.5 times the cost of production, may also drive inflation up, although its impact cannot be ascertained as yet, she said.

Fiscal slippage

Voting for maintaining status quo on both the policy rate and a neutral stance, Ravindra H Dholakia, Professor, Indian Institute of Management, Ahmedabad, said inflation trends need to be watched carefully. Although the base effects are going to be favourable over the next three to four months, the oil price movements can create uncertainties and serious upside risks.

“The fiscal space to accommodate future higher oil price shocks seems to be absent given the slippage in the Union Budget for 2018-19. The impact of the increase in customs duty and MSP proposed in the Budget on the headline inflation is again uncertain. Although there is substantial fiscal slippage by the Centre, the fiscal performance of major States needs to be watched,” he said.

Michael Debabrata Patra, RBI Executive Director, who voted for a 25 basis points increase in repo rate to 6.25 per cent, said several drivers of inflation are firing at the same time — upward adjustments of domestic POL (petroleum, oil and lubricant) prices in response to the hardening of international crude prices, imminent MSP increases, fiscal slippage, and customs duty increases.

“Various measures of underlying inflation are converging to the headline at above 5 per cent. Expectations are elevated and volatile. Fixed income markets are telling us that we have fallen behind the curve,” explained Patra.

Viral V Acharya, RBI Deputy Governor, who voted for a pause with no change in the neutral stance, emphasised that headline inflation prints since last policy have been significantly above the target. While a part of this is statistical due to the Centre’s HRA implementation, there has also been a rise in inflation sans HRA.

“A major concern has been the steep rise in oil prices, coincidentally with: global rates and commodity cycles having turned up; and our fiscal deficit having overshot for this year and likely to do so next year too.

“Hence, even without factoring in the States’ staggered HRA implementation and MSP rises announced in the Union Budget, risks to inflation seem clearly tilted on the upside,” explained Acharya.

Finally, Urjit Patel, RBI Governor, who too voted for keeping the policy repo rate on hold while maintaining a neutral stance, said looking forward, inflation in the baseline scenario is projected to remain above the target of 4 per cent throughout 2018-19.