RBI’s April policy stance was more hawkish than expected. The statement suggests that RBI is ready to tolerate slower near-term growth, but not higher inflation, as the latter will derail long-run growth prospects. Surely, there is no growth/inflation trade-off in the long run, but the near-term outlook looks difficult.
Given the lag in policy transmission, suppressed domestic fuel prices and cost pressures, aggressive rate hikes will not affect near-term inflation. We continue to expect wholesale price index (WPI) inflation to accelerate over the next two quarters towards double-digits.
Inflation is no doubt very high, but when it is partly being driven by structural supply-side constraints, as is the case in India, fiscal policy is just as important to check inflation. Focusing only on aggressive monetary tightening — especially after 400 basis points of effective tightening and when growth indicators are already faltering — could choke growth with only a limited effect on taming inflation.
Meanwhile, risks to the growth outlook have risen. Already, near-term GDP growth is likely to slow below 8 per cent due to sluggish investment activity, while steep rate hikes could start to hurt so-far buoyant consumption demand. RBI’s rate actions suggest a few years of growth at or below trend is a necessary and acceptable evil to contain inflation and inflation expectations. This can be justified from the perspective of sustaining medium-term growth, but the adjustment path for the economy will be a difficult one.
Sonal Varma, India economist, Nomura Financial Advisory and Securities
