Inflationary pressures continue to worry members of the Reserve Bank of India’s Monetary Policy Committee (MPC) even as they have noted the need for more rate hikes and the slowing down of the economy as a result of this.

The six-member MPC, headed by the RBI Governor, raised the benchmark repo rate by 50 basis points (bps) on 8 June, following the first increase by 40 bps at an unscheduled meeting on 4 May.

“High inflation continues to be the major concern while revival of economic activity remains steady and is gaining traction,” RBI Governor Shaktikanta Das said at the committee meeting held between 6-8 June.

“The war has globalised inflationary pressures across geographies and there are increasing risks of long-term inflation expectations getting unanchored. While prices of a few commodities – such as metals and fertilisers – have seen some softening, most food and all energy prices remain elevated,” Das added.

For taming inflation, the RBI, according to market expectations, will carry out a series of rate hikes over the year. This will curb consumer demand and slow down the economy. 

“In the process (of rate hikes), spending will slow down, so will demand, and so will the economy. The objective should be to take the repo rate to a height that is at least above the four quarters ahead forecast of inflation, knowing that monetary policy works with lags. Concomitantly, it is important to condition public perceptions and expectations that growth will be closer to 6% than to 7% in 2023-24, as a result of monetary tightening," said RBI deputy governor and MPC member Michael Patra.

Runaway inflation could corrode the foundations of the recovery that is gradually gaining traction, Patra said. In India, inflation above 6% deters investment decisions, causes depositors to worry about negative returns and, hence, shift to time-tested holders of value like gold. This, he said, triggers capital flight and exchange rate depreciation, raising imported inflation. 

The consumer price index (CPI) inflation stood at 7.04% in May. This was the fifth consecutive month of inflation being above the RBI’s upper tolerance limit of 6%.

RBI expects the inflation levels to moderate only by the first quarter of the financial year 2023-24. “Given the extraordinary circumstances driving up inflation the world over, our endeavour should be to bring down inflation into the tolerance band by the last quarter of 2022-23 or the first quarter of 2023-24 and progressively align it to the target during the course of 2023-24,” Patra said, as per the minutes of the meeting which was released on Tuesday.

“Across the developing world, food shortages will likely last through this year and the early part of next year, exacerbating the pain of soaring food prices. Even in the world’s rich¬est nations, higher food prices are causing food poverty for the first time in a generation,” Patra added.

Jayant Verma batted for a 100 bps hike and said there was a lot of catching-up to do.

“Between April and now, the MPC has raised the policy rate by 90 basis points, but during the same period, the RBI’s projection of inflation for the year 2022-23 has risen by 100 basis points from 5.7% to 6.7%. The real policy rate, therefore, remains more or less where it was in April. This reminds me of Lewis Carroll’s adage that we must run as fast as we can, just to stay in place; and to go anywhere, we must run even faster. Clearly, more needs to be done in future meetings to bring the real policy rate to a modestly positive level consistent with the emerging inflation and growth dynamics," he added.

MPC member Ashima Goyal believed that at the current stage of recovery, the one-year ahead real rate must not be more negative than -1%.

“A 50 or 60 basis point hike would achieve this, while looking through part of the spike in 2022, even as further supply-side movement and clarity on global developments are awaited. Such a real interest rate, while not dampening the recovery much, will prevent a possibly further inflationary rise in demand and unsustainable current account deficit," said Goyal.

According to Rajiv Ranjan, fighting inflation should be the joint responsibility of the RBI and the government.

“In this context, with monetary policy prioritising price stability and fiscal policy emphasising on quality of expenditure through capex, the economy becomes the net beneficiary. Thus, it may be important for the government—both Centre and states—to successfully complete their budgeted capex plans and work through their counter-cyclical policy levers to ensure a soft-landing for the economy amidst monetary tightening to rein in inflation," said Ranjan.

To tackle inflation, RBI raised rates by 90 basis points in two tranches in a month. But the repo rate is still lower and the liquidity higher than the pre-pandemic days, Das said.

“Our policy in recent months has been unambiguously focused on withdrawal of accommodation, both in terms of liquidity and rates. The change in wording of stance should be seen as a continuation and fine-tuning of our recent approach. The withdrawal of accommodation, as I see it, would be non-disruptive to the process of recovery and would strengthen our ongoing efforts to combat inflation and anchor inflation expectations,” the RBI governor added.