Rate status quo affirms inflation focus

Retail inflation had trended below the RBI’s 4 per cent tolerance line in August this year but later moved up in September and October, driven by higher food prices.

It is not surprising that the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), at its review last week, decided to maintain the status quo on the benchmark interest rate, retaining it at 6.5 per cent. This is the 11th consecutive time that it has kept the rate unchanged. There was speculation that the MPC would take a more benign view of inflation now. At its previous meeting it had, while retaining the rate, changed its policy stance from ‘withdrawal of accommodation’ to neutral. This was considered as a signal for rate reductions in future. It was also thought that the second quarter GDP shocker, where growth slowed down to a seven-quarter low of 5.4%, would prompt the MPC to soften its position. There were calls for rate cuts from Finance Minister Nirmala Sitharaman and Commerce Minister Piyush Goyal. But the RBI decided not to waver on its basic mandate to keep inflation in check. It is by law bound to honour it.

Retail inflation had trended below the RBI’s 4% tolerance line in August this year but later moved up in September and October, driven by higher food prices. The RBI expects food prices to remain high in the third quarter, and to ease only towards the end of the year. It said the moderation may occur because of “seasonal correction in vegetable prices, kharif harvest arrivals, likely good rabi output and adequate cereal buffer stocks”. It expects inflation to be at 5.7% in the third quarter, and to fall to 4.5% in the fourth quarter. Its 4% target may be achieved only in the second quarter of the next financial year. So it has seen no reason to relax its watch.

The committee has felt that the outlook for growth is “resilient”, though it has slowed down. Governor Shaktikanta Das noted that the momentum has “recovered, aided by strong festive demand and pick-up in rural activities.” The RBI has projected GDP growth to bounce back to 6.8% in the third quarter and to 7.2% in the fourth quarter. Though it ruled against a rate cut, it has announced a cut in the cash reserve ratio which would increase the lendable resources of the banking system, aiding growth. The next two months are important for many reasons. Apart from the ongoing wars and conflicts, Donald Trump’s decisions after assuming office in January and the Union budget, to be presented on February 1, will impact policy decisions in the coming months. While these are important, the RBI has made it clear that its focus will be on the price line.