MPC minutes of RBI: Inflation fears, driven by oil prices, led to rate hike

The MPC members raised concerns about the risk to the inflation target due to the impact from MSP rise for crops, elevated crude prices and other factors

Risk of inflationary pressures, triggered by rising crude oil prices, drove five-member of the monetary policy committee (MPC) in its August review to favour a hike in policy rate for the second time in a row. 

While external member Ravindra Dholakia favoured a status quo, all six members voted for the policy stance to remain neutral. 

The MPC members raised concerns about the risk to the inflation target due to the impact from minimum support price (MSP) rise for crops, elevated crude prices and other factors such as increase in house rent allowance and monsoon conditions. Positive growth outlook and indications of output gap closing were also key factors for the rate hike vote. 

Following the rate hike of 25 basis points, which was anticipated by many in the market, the policy repo rate stands at 6.5 per cent. 

RBI governor Urjit Patel said the hike was "a necessary step towards securing the mandated 4 per cent inflation target on a durable basis" as inflation risks have continued to be elevated. He said CPI, excluding HRA, rose for the third consecutive month in June 2018, driven by a broad-based increase in inflation in non-food goods and services. 

Pami Dua, another external member on the MPC and director of the Delhi School of Economics, cited the hardening of actual inflation, rising inflation expectations, along with prevailing upside risks to inflation as reasons for hike. 

Viral Acharya, deputy governor said the upside risks are higher than downside risk as real-time indicators indicate growth recovery to be sustainable. He said, "The underlying inflation as reflected, especially in petrol and diesel, transportation (including fares), education fees, health services and clothing persists, and does not augur well for headline inflation going forward." 
Acharya said that the hike would "help rein in demand pressures and manage inflation expectations".  

Michael B Patra, executive director, RBI, said that the second hike would work its way through the economy, while vigil is kept on the expected rising path of inflation going forward. "The softer inflation prints expected in Q2 could likely lull inflation expectations, but abundant precaution and decisiveness in quelling risks to the target is warranted if the hard-earned gains in terms of macroeconomic stability and credibility have to be preserved," he added. 
 

Dholakhia said that the monthly headline inflation prints for May and June have turned out to be lower than RBI expectations. He added that the current RBI forecast does not show this decline, on the contrary it projects an increase by about 20 bps only because it incorporates a remotely possible impact of MSP revisions on the headline inflation. He said that one should 'wait and watch' till the revised MSP is implemented on the ground by November 2018. 

"This is certainly not the time and environment to hike the policy rate. Nor is it the time to tinker with the policy stance. Prudence lies in maintaining status quo on both," said Dholakia. 

He cited the possibility of GST rate reductions, marginal decrease in oil prices as well as slowdown of growth both domestic and global contributing to downward inflationary risks. 

"Only the most uncertain impact of MSP revisions on food prices after 2 or 3 quarters can push the inflation forecast marginally higher. In my opinion, we should not consider such a highly uncertain impact for a rate hike decision," he added. 

Chetan Ghate, MPC member and professor at the Indian Statistical Institute said that the magnitude of MSP impact makes it "opportune to frontload a rate hike, somewhat akin to an 'insurance policy'." 

Dholakia had unanimously voted for 25ps hike in the earlier June MPC meeting. He had, however, indicated towards inflation prints being lower than expectations. Earlier, he was the only dissenting member to advocate for rate cuts, while the rest of the committee voted for status quo.