Why RBI panel voted for rate hike, minutes of June 4-6 review

At its review earlier this month, the monetary policy committee (MPC) of the Reserve Bank cited volatility in the price of imported crude oil as the biggest concern for the economy, nudging the panel to effect a rate hike after years.

All six members of the MPC maintained their neutral policy stance and also voted in favour of a repo rate increase of 25 basis points to 6.25 per cent, reveal the minutes of that June 4-6 meeting. The minutes were published on Wednesday. 

Ravindra H Dholakia, external expert on the panel, had been a votary for rate cuts in the past. At this meet, his view had changed, noting rising inflation risk, saying: "Prudence lies in retaining the neutral policy stance but increase the policy rate by 25 bps for now...oil prices have further firmed up and geo-political developments indicate no respite likely on that count soon. For the next 12-18 months, oil prices are likely to stay at higher levels, adding to the twin deficits (fiscal and current account) and inflationary pressures.” 

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Brent crude oil prices rose from $66.82 a barrel at the start of the year to a high of $79.18 at end-May, an 18.5 per cent rise. As of Wednesday, though, the price was $74.65 a barrel, an 11.7 per cent rise since January. "There are chances that headline CPI (consumer price index) prints in the coming months might turn out to be lower than expected by RBI and, in such a case, the inflation forecast for 12 months ahead might come down. Although such possibilities are not ruled out, their chances are less," Dholakia said. 

Chetan Ghate, another MPC member and professor at the Indian Statistical Institute, said the major upside risk to the year-ahead CPI projection was the price of oil. “Volatility in the price of oil needs to be carefully watched, especially because higher fuel prices have helped harden inflationary expectations (both three-month ahead and one-year ahead) to their highest level since September 2016,” he had said. 

Urjit Patel, the RBI governor, seconded this concern, saying: The recent increase in oil prices, by impacting disposable incomes, may have some adverse impact on private consumption.” However, “inflation in March and April behaved more or less on the lines of the path projected in the April resolution.” 

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Viral Acharya, deputy governor, felt “inflationary pressure also seems to be experienced by the common man”. At the earlier review in April, he had indicated concerns surrounding underlying inflationary pressure. Which had, he said, since manifested, in terms of rising inflation (CPI), even after excluding food items and after adjusting for the impact of the Centre’s House Rent Allowances (HRA). 

UPSIDE RISKS TO INFLATION
 

Rising crude oil prices
 

Higher commodity prices globally
 

Implementation of HRA revisions (state governments
 

Kharif minimum support prices will be hiked
 

Risk of fiscal slippage 
 

Depreciating Indian Rupee 

The CPI change had become “firmer on the upside”, moving closer to five per cent and away from four per cent. Under its inflation targeting regime, the MPC is mandated to ensure the medium-term target for CPI inflation is kept at four per cent, within a band of two per cent either way.

CPI inflation, excluding the HRA impact, has averaged 4.4 per cent since November 2017, reaching a high of 4.87 per cent at the end of May.  

“The one respite for headline inflation prints has been the continuing benign food inflation, where seasonal pick-up has remained muted due to a collapse in the prices of onions and tomatoes. This has imparted a short-run softening to inflation projections, keeping them contained in the first half of 2018-19,” Acharya had said. 

The rising prices would be contained, in spite of the rising momentum in CPI (excluding fuel, food and HRA), he said. However, a seasonal pick-up or any “upward pressure on food prices such as through generous minimum support prices (MSPs) would exacerbate headline inflation pressures”. 

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Michael B Patra, executive director at RBI, also voted in favour of the repo rate hike. Stating: “Continuing policy inaction is running the danger of allowing inflation outcomes to slip away from the centre of the target band. The gains of macro economic stability that have defined the recent period as its greatest achievement could get frittered away.” 

The effect of oil supply cuts by the Opec multi-country cartel and Russia, combined with geo-political pressures on Iran and a supply shock in Venezuela, had pushed crude prices to “uncomfortable” levels, Acharya felt. RBI’s Inflation Expectations Survey of Households, conducted in May, illustrated that household expectations on inflation in the future was hardening. "Reflecting a deteriorating outlook with respect to the price situation,” said Pami Dua, another external member on the MPC, also director at the Delhi School of Economics.  

On overall growth of the economy, the RBI chief stated the rise in Gross Domestic Product was at a seven-quarter high of 7.7 per cent for January-March 2018. “There has also been a pick-up in manufacturing and this is manifested in an increase in capacity utilisation. The services sector has been resilient, with several high-frequency indicators continuing to show robust growth in recent months,” Patel said. Also noting a growth in bank credit. 

“Capacity utilisation has increased substantially as revealed by different surveys. Growth in capital formation has also picked up. All this indicates the output gap has started closing,” Dholakia had added.  Commenting on the minutes, Aditi Nayar, principal economist at ratings agency ICRA, said this was likely to be a shallow rate hike cycle. "We may see one or a maximum of two more rate hikes, depending on the extent to which inflationary risks materialise, without necessarily getting a change in stance. A change in stance would likely signal that a series of rate hikes are in the offing," she said.