Will MPC be able to decide on its own?

 Whether the pause in  repo rate will continue?

The Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) is meeting in Mumbai tomorrow, to review the policy (repo) rate and the monetary policy stance for the next two months. 

Notable developments, since the last meeting in Oct 24 include,
(i) CPI inflation rate at 5.49% in Sep 24  and 6.21% in Oct 24 was much higher than the target rate of 4% fixed for monitoring inflation.

(ii) GDP growth at 5.4% in Q2FY24 was a dampener.

As the inflation rate is much in excess of the target rate and is also above the tolerance level (of +/-2%) for the month of Oct 24, one expects no change in the existing repo rate and monetary stance. (I factored in the consistent statements of the RBI Governor that bringing down the inflation level below the target rate is the top priority). However, contrary views are expressed by some of the ministers and the chief economic advisor to the central government that there is a need to exclude food inflation for arriving at CPI inflation. 

Some comments and my views are as under:
1. Commerce Minister said "it is a flawed theory" to consider food inflation, while deciding on rates, that "RBI should cut interest rates" and "Growth needs a further impetus". The economic survey suggested to exclude food from inflation calculations and the Chief Economic Advisor to the Government of India endorsed it during his conversations with the media and in his speeches in the economic conclaves.

My views: RBI switched from wholesale price index (WPI) to consumer price index (CPI) in April 2014, based on Dr. Urjit Patel Committee's recommendations, as the committee felt CPI is the 'primary indicator' of inflation. It further said CPI, with more weightage to food and beverages, represents the actual 'cost of living'. In fact, during 2018-19, the voice to reduce RBI policy rate was more heard, as food and beverages inflation was more on the decline than core inflation (it even recorded negative figures in one quarter). In addition to the comments from the government and its officials, more views are aired now in support of the argument to exclude food from CPI inflation for arriving at policy rates, not from economists but from industrialists and active stock market players. In the same way RBI believes that monetary policy measures alone are sufficient to bring down inflation under control, the other side try to impress that reduced interest rate is the only way to boost up growth and the economy.  When the MPC changed its stance to 'neutral' in Oct 24, it helped stock markets to stage a rally for a short period. If the repo rate is reduced now, growth may not pick up, but may spur the stock prices for a few days. The real reason for the decline in growth in the first and second quarters lies elsewhere and not with the policy rate per se.

2. Finance Minister observed "when we want industries to ramp up and move, build capacities, bank rates will have to be far more affordable" so that "Viksit Bharat not just an aspiration but a reality". I take it not as a suggestion to the MPC of RBI to reduce repo rate ignoring higher inflation, but as a call to commercial bankers, since their net interest margins are much higher, in spite of the increase in deposit rates in the last one year. (4 plus for private banks and 3.5 plus for public sector banks). The higher NIM helps some of the banks to cross subsidize their otherwise flat non-interest income, go for branch expansion spree and provide for more technical write-offs (than actual recoveries) to have GNPA at more acceptable levels. There is still scope for reducing interest rates by the banks on their own, without taking an excuse that the repo rate remain unchanged.

3. Some are arguing that a cut in CRR by 50 basis points is desirable, as not all the banks are flush with funds. I welcome this, not from the angle of liquidity that will come into the banking system, but from the point of enabling the banks to reduce lending rates, without the need to reduce the rates on its deposits. (It may also help RBI to say that while repo rate is unchanged as inflation is much higher than target, it is mindful of supporting growth).

Summary: 
Though (i) FED reduced its rates in its last two meetings and indicated it will continue in the same direction, (ii) a  few other major economies followed that decision and (iii) China is on a stimulus spree to bring back its ailing economy on track, the ground realities in India are totally different. The inflation numbers published are not in isolation, but reflects the deficit in balance of payments on account of continued deficit in merchandise imports, Forex reserves (more from capital account), value of Indian Rupee, prices of essential commodities and services, transportation cost and various other factors. Hence the headline CPI inflation continues to be the 'dominant' factor in decision making and not the 'core inflation' excluding food items. 

The proposed meeting from 4th Oct - 6th Oct 2024 will be the first litmus test for the MPC. Its deliberations and decisions in the meeting will set the tone for its future meetings. Expectations from the MPC is - 'let the policy rate and stance be constant and do not change'

Regards

V. Viswanathan
3rd December 2024