Unfinished battle

RBI will need to do more to contain inflation

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), in its first meeting of the new fiscal year this week, would have to adjust both its inflation projection and policy response. In its last meeting, the MPC had projected the consumer price index-based inflation rate for the January-March quarter at 5.7 per cent. However, the outcomes so far have surprised on the upside with the rate once again climbing above the upper end of the tolerance band. The average for the quarter is thus likely to be above the projected level. Given the inflation condition and consistent surprises on the upside, the markets would also keenly watch if the central bank adjusts its inflation projection for the current fiscal year. As of now, it expects an average inflation rate of 5.3 per cent in 2023-24.

Given the fact that the inflation outcomes have been above expectations, the MPC would have to adjust the policy rate. An overwhelming majority of economists and analysts expect the rate-setting committee to increase the policy repo rate by another 25 basis points. The committee has so far increased the repo rate by 250 basis points in the current cycle, and there are reasons for another hike. As mentioned above, the inflation rate has once again gone above the upper end of the tolerance band. It would thus be important for the central bank to continue its fight. Besides the headline rate, core inflation also remains sticky and is a worrying factor for the central bank. Further, although the last projection pegged the inflation rate at 5.3 per cent for 2023-24, the rate was expected to increase from 5 per cent in the first quarter to 5.6 per cent in the fourth quarter, which is significantly above the target of 4 per cent.

In terms of global factors, the outlook remains mixed. The inflation rate in the euro zone declined sharply to 6.9 per cent in March from 8.5 per cent in February, largely because of a fall in energy prices, which could get somewhat reversed with the latest decision of large oil producers to cut output. Also, the core inflation rate inched up to a new high of 5.7 per cent. This indicates the nature of price pressure and the kind of efforts the European Central Bank will need to make to reach the target of 2 per cent. Meanwhile, in the US, despite the turmoil in the banking system, the Federal Reserve (Fed) decided to increase the policy rate in March, signalling that it would deal with inflation and stress in the banking sector separately. However, friction in the banking system, which would affect economic activities, will ease the need for monetary-policy tightening. Official projections suggest the Fed will increase the policy rate by another 25 basis point this year.

Lower than previously expected monetary tightening by the Fed would reduce pressure in the currency markets and help countries like India in managing external accounts. This, along with moderation in the current-account deficit, will allow the RBI to focus on containing inflation. With the given inflation backdrop, it makes sense for the MPC to raise the policy rate this week. It may, thereafter, depending on macroeconomic conditions, pause to see the impact of cumulative rate hikes. The present and projected levels are way above the target of 4 per cent.