The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) maintained the status quo on interest rates

• Recently, the Monetary Policy Committee (MPC) maintained the status quo on interest rates and retained its stance of withdrawing accommodation.
• The RBI prefers higher rates for longer periods for both domestic and external reasons.

Domestic Reasons

• In the beginning of the second quarter of this fiscal year prices of tomatoes and other food items rose significantly.
• It became more concerning with volatile and rising crude oil prices.
• The RBI Governor noted that the transmission of past rate hikes to bank lending and deposit rates remains incomplete.
• These factors have nudged the MPC to hold its stance of “withdrawal of accommodation

External Reasons

• The continuation of hawkish monetary policies by major central banks, especially the US Federal Reserve
• The rise in crude oil prices

Hawkish Policy of Major Central Banks

• Global central banks have been on their toes since Covid-19 struck.
• First, they had to ease monetary policy rapidly to fight an economic collapse, and then hike repeatedly to tame inflation.
• Central banks in the advanced countries may opt for a cautious approach and keep rates higher for longer given the challenges in inflation control.
• As a result of this position, the US 10-year treasury yield has surged to 4.8 percent, marking its highest level in 16 years.
• This is attracting capital to the US and away from the emerging markets, and strengthening the dollar and the rupee, not surprisingly, has been under the pump.

India’s Current Scenario

• India’s growth has held strong despite costlier crude oil, weakening rupee and pressure on food inflation from an erratic monsoon.
• Supply shocks amid healthy growth will keep the RBI cautious.
  • RBI has already raised its inflation forecast for this fiscal to 5.4 per cent from the 5.2 per cent made in June.
• The fresh arrivals have corrected vegetable prices, and crushed those of tomatoes, causing angst at farms.
• Consequently, August inflation softened to 6.8 per cent.
• RBI’s inflation for the second quarter at 6.4 percent implicitly assumes around 5 percent inflation in September.

Challenges Ahead

• The concern over cereals, pulses and spices inflation persists given their double-digit readings.
• The overall kharif sowing is only marginally above last fiscal’s level and lags for pulses and jute.
• The forecast for El Nino conditions persisting until the end of the year, is also alarming.
• The southwest monsoon also influences groundwater and reservoir levels for the rabi or winter crop, which is produced in largely irrigated areas.
• Central Water Commission Data
  • As on September 29, live storage at reservoirs was 82% of the previous year’s corresponding levels and 92% of the decadal average.
• The volatile crude oil prices have emerged as another potential risk.
  • India is highly vulnerable here because around 85% of its requirement is imported.
• If they rise and sustain at elevated levels, headline inflation can rise via direct and indirect effects of higher production and transportation costs.
• In addition, higher crude prices create upside risks for the current account and fiscal deficit, and a downside risk to growth