The Reserve Bank of India appears to be in its final leg of bringing inflation to heel. Though headline inflation is showing steady signs of easing, the central bank’s six-member Monetary Policy Committee (MPC) is steadfast on retaining repo rate at 6.5 percent as any “premature move (to cut rates) may undermine the success achieved so far”.
As we navigate the ‘last mile’ of disinflation, the policy imperative is to ensure a durable decline in price rise and aligning not just headline, but also core inflation, to the 4 percent target. If declining global commodity prices and higher government capex are positive signs for growth, the government’s fiscal consolidation drive will help lower inflationary pressures and the evolving trajectory of current account deficit suggest that India is well placed in terms of macro-financial stability.
That said, consumption demand revival holds the key in sustaining the current growth momentum, which in turn depends on falling unemployment and rising household income. As it is, private consumption, which accounts for 57 percent of the GDP, continues to suffer due to elevated food inflation, particularly in rural areas. High inflation erodes purchasing power, especially among the low-income brackets; so restoring price stability is non-negotiable.
While a tight monetary policy lowers high inflation, it is important to minimise the output costs of disinflation during the process. As such, the current real interest rate of 2 percent (repo rate adjusted for year-ahead inflation projections) “creates the very real risk of turning growth pessimism into a self-fulfilling prophecy”, and hence the MPC’s external member Prof Jayanth R Varma, the lone dissenter, is batting for a 0.25 percentage point rate cut.
While the government’s ongoing prudent fiscal policy certainly helps anchor the long-term inflation expectations of market participants, the implications of the elevated food inflation to the overall pricing pressures and its volatile nature are hard to miss.
Which is why, the majority of the MPC is firm on sticking to a tight monetary policy to rein in household inflation expectations and arrive at the 4 percent target. As we navigate disinflation, RBI’s caution and conservatism are welcome. At the same time, the central bank also has to undertake the most difficult job of ensuring that it does not move too soon or wait too long to cut rates.