How inflation defeated the RBI : A recent history of MPC Statements

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How inflation defeated the RBI : A recent history of MPC Statements

  • RBI is expected to both raise the interest rate and slash the amount of money in the financial system to control retail inflation when it announces its monetary policy statement on June 8.
  • More than the quantum of the anticipated hike in the repo rate, RBI's outlook on inflation will be important.

Inflation since Oct 2019

  • Retail inflation in India has been above the RBI's target rate of 4% since October 2019. Only on three occasions (months) in the past 30 months has retail inflation come dose to 4%.
  • In August 2019, retail inflation was comfortably below RBI's target rate, and the MPC, noting that "inflation is currently projected to remain within the target over a 12-month ahead horizon", decided to cut the repo rate by 35 basis points(or035%) from 5.75% to 5.40%.
  • In December, it noted that "retail inflation increased sharply to 4.6 percent in October, propelled by a surge in food prices (and) the CPI inflation projection is revised upwards to 5.1-4.7 percent for H2:2019-20 and 4.0-3.8 percent for H1:2020-21". The spike in inflation made the RBI pause its repo rate cuts despite continued weakness in economic growth.
  • The pandemic had already started disrupting Western economies, and the RBl was increasingly in a bind over whether to raise interest rates to control inflation or cut them to boost decelerating growth momentum. It decided to keep the policy repo rate unchanged and persevere with the accommodative stance as long as necessary to revive growth while ensuring that inflation remains within the target".

During the pandemic

  • In March 2020, the MPC noted that given that "macroeconomic risks, both on the demand and supply sides, brought on by the pandemic could be severe", it was important 'to do whatever is necessary to shield the domestic economy from the pandemic". It cut the repo rate by another 75 basis points from 5.15% to 4.40%.
  • In October, the MPC noted that "headline CPl inflation increased to 6.7 percent during July-August 2020", but took the view that the "revival of the economy from an unprecedented COVID-19 pandemic assumes the highest priority", and decided to maintain the status quo on the policy rate
  • In December, the RBI expressed surprise that the outlook for inflation has turned adverse relative to expectations in the last two months".

Road to the rate hike

  • In April, the MPC said "headline inflation increased to 5.0 percent in February after having eased to 4.1 percent in January 2021", and "core inflation increased to touch 6 percent". But as Covid cases spiked, it made no change in the repo rate.
  • In December, the MPC noted that core inflation was elevated in September and October, but kept the repo rate unchanged. It chose to stay with an accommodative stance "as long as necessary to revive and sustain growth on a durable basis". As the chart shows, that retail inflation yet again breached the 5% mark in December
  • In February 2022, despite rising headline CPl inflation and core inflation, RBI projected CPlinflation for 2022-23 at 4.5%. But by April, it had found that even without any direct impact of the Ukraine conflict, headline CPI inflation had edged up to 6.0 percent in January 2022 and 6.1% in February. Core inflation, too, hovered around 6%.

Prelims Takeaway:

  • Retail Inflation
  • Inflation Targeting
  • MPC
  • Core Inflation and Headline Inflation
  • Repo Rate