RBI monetary policy: Room squeezed out, says IDFC First Bank economist

The Reserve Bank of India (RBI) is faced up with a challenging situation of a surge in inflation coming alongside a sharp contraction in growth conditions. After the August meeting, we have seen two more retail inflation prints and both have been adverse – July number at 6.73 per cent and August at 6.69 per cent. We expect no comfort to the headline CPI numbers for September, given the repeat spurt in vegetable prices. Core inflation has also remained sticky. Post the MPC meeting in August, we came to know that the GDP numbers for the first quarter was at a worse-than-expected level of -23.9 per cent. 

What is important is that headline CPI inflation will now be higher than the upper band of the inflation target for six months in succession and the trailing 12-month headline CPI averages at 6.22 per cent. Minutes of the last meeting did indicate the MPC’s worry on the inflation trend, with one MPC member arguing that India’s adverse supply shocks appear to be more severe than the demand side shocks. Importantly, the prices of protein-rich items such as meat and fish and eggs remain elevated. It would be hard to tell immediately if the increase in the prices of protein items is due to a demand spurt or supply shortages.  

Indranil Pan Chief, Economist, IDFC FIRST Bank

Price trends for non-food categories, on the other hand, is also faced with uncertainties. While tax increases led to an increase in the prices of petroleum products, this could lead to broad-based cost push pressures through the transportation channel. On the other hand, there might be another round of increase in telecom tariffs (already signalled by the telecom companies) while any sustained significant reduction in gold prices, another factor that led to the firmness in retail core inflation, is ruled out. While the inflation story is extremely dynamic, our current inflation assessment points towards the fact that headline CPI inflation could continue to remain above the 6-per cent mark for a couple of months more and moderate below 6-per cent thereafter. However, given the opposite pulls from the supply and the demand sides, the pace of drop could be muted, and we now expect inflation to average at 3.8-3.9 per cent in Q4FY21. Given these uncertainties of inflation trajectory, it may be risky for the RBI to take a call to cut the repo right away. Importantly, July survey of household inflation expectations continue to indicate elevated levels of expectations one year ahead. This implies that the newly crafted MPC would, in most likelihood, play safe and continue to remain on a wait-and-watch mode. 

While we expect the next policy to be a non-event so far as rates and liquidity measures are concerned, the RBI must make public its views on growth and inflation for the year, something that the RBI has desisted from doing till now. Further, the role of the RBI in the current atmosphere is likely to be challenging from other aspects, including maintaining financial stability, and that is where the critical focus of the market has to be and not merely on the rate-setting exercise. 

Above reflects personal views