Having voted against the repo rate cut in the February monetary policy, when Acharya was asked to answer questions on inflation by his boss Das in the post-monetary policy press conference, he had said, “food is a volatile component in all the economies. In economies where food is a bigger proportion of the basket, these are the central banks that tend to make larger errors...”.
On Thursday, when the minutes of monetary policy committee (MPC) was out, it showed that Acharya wanted a wait and watch on the rate cut because in his views there were no definitive signs of inflation softening on a broad base.
Around a fortnight after the repo rate cut, the first signs started appearing on why the MPC should have waited for a few more inflation prints before slashing the rates. Crude oil prices, a major concern expressed by Acharya while the decision was underway in the MPC, have hit a fresh 2019 high and core inflation remains a scare.
Acharya had said that inflation excluding food and fuel remained “elevated and persistent”. He had said that inflation in health and education had moved sharply upward and if these two sustained, they could push non-food and non-fuel inflation into uncomfortable territory.
Unfortunately, he said, there was no decisive way to resolve this issue other than to wait and analyse a few more prints. He flagged concern over the vulnerability of vegetable prices as well, which could take a sudden reversal from their deflationary momentum.
His second concern was international Brent crude prices, which though had stabilised in the short run, he was of the opinion that it was too early to rule out wild gyrations from geopolitical risks.
He also opposed the rate after watching the government’s fiscal response to agrarian distress, which he said, might play out over the next 12 months and partly beyond and that could get generalised into headline inflation. Besides, he had also warned on inflation expectation of the households, which still ran high on a long term basis.
It was as if his prophetic words came true. When the inflation expectation survey of RBI came out almost simultaneously with the monetary policy, it showed that households were living under the fear that inflation may rise in the near future. Given the elevated level of inflation excluding food and fuel, he felt that keeping the policy rate at 6.5% was just right over the medium term.
However, Das was not on the same page as his deputy though he did not give substantial reasons for his support for the repo rate cut. He did not see inflation moving too high in the near future and even though core inflation was almost near 6%, he made a mention about it in his discussion.
Volatile oil prices too found just a passing mention by Das’s explanation. Das’s arguments were more inclined towards supporting economic growth rather than targeting inflation aggressively. This is what the government actually wants at the time when it is going to seek votes from people.
While all the MPC members had voted for a shift in the policy stance to ‘neutral’ from ‘calibrated tightening’, Chetan Ghate was another one who followed Acharya on rate cut restraint.
Acharya said his inflation and growth assessments, and given the MPC’s mandate to target headline inflation at 4% on a durable basis while paying attention to growth, he preferred to “take off the helmet” but “stayed within the crease”. That is, he voted for a change in the stance from calibrated tightening to neutral to retain policy flexibility at future dates based on incoming data, but to hold the policy rate at 6.5%. Following the policy, most of the analysts said that they expected another one by April.
“In sync with the policy statement, the minutes also reaffirm our view of another cut in the repo rate by 25 bps to 6%. Softer-than-expected January CPI (Consumer Price Index) print of 2.05%, MPC’s downward revision of 60-80 bps to the MPC’s H1 FY’20 inflation projections to 3.2-3.4% and the opening up of the output gap have improved the probability of multiple rate cuts in 2019,” Kotak Reseach said.
It also estimated that while inflation in the near term was likely to remain benign, any further monetary accommodation would hinge on the evolution of inflation and growth dynamics.
“We believe that the MPC would be constrained to cut rates aggressively as we expect inflation to inch over 4% in H2 FY20, with upside risks from volatility in food and fuel prices, monsoon, fiscal slippages, and elevated core inflation,” Kotak said.
Das had surprised the street by a rate cut when the fiscal policy too was moving loosely ahead as reflected in the Interim Budget of 2019-20. He may have seen inflation softening for now, but a reversal in food inflation and the onset of summer is not ruled out.
The low acreage of Rabi crop sowing this time around too has raised the spectre of inflation in the coming months. Oil prices are already showing a rising trend in the hope of US-China trade ties getting through.
When does a central bank actually execute a repo rate cut? It is at the time when RBI’s reasonably confident that inflation and fiscal deficit are in control and a demand-led price surge is unlikely. When the economy is slowing down and the RBI wants to accelerate growth by signaling an accommodative monetary policy.
So, going by the textbook economics, RBI could have held on to the rates and that is the major reason Acharya advocated for a hold. Acharya’s comments were significant as only months ago he had warned the governments against stemming central banks’ autonomy.