Inflation, the key challenge

RBI’s decisions indicate that the economy will remain volatile in the near-term

Reserve Bank of India governor Shaktikanta Das surprised everyone when he said that the Monetary Policy Committee (MPC) of the central bank convened an unscheduled meeting between May 2 and 4, and decided to hike the policy rate by 40 basis points and the Cash Reserve Ratio (CRR) by 50 basis points. As a result, the revised policy rate and CRR now stand at 4.4% and 4.5% respectively.

While the MPC has kept the official stance of monetary policy as accommodative, it has reiterated that it is being “accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target”. That a reversal in the easy money policy, both in terms of interest rates and liquidity, was on the cards was clear from the tone of the April MPC resolution.

But what forced the MPC to announce a rate hike and CRR increase in an unscheduled meeting? Various factors such as the expectation of a sharp interest rate hike by the United States Federal Reserve — RBI’s announcement came hours before it — or a higher-than-expected inflation reading in April 2022 — the Consumer Price Index growth in March 2022 was 6.95% — could have played a role. However, what the MPC resolution says explicitly to justify its action is that there are “significant upside risks to the inflation trajectory set out in the April statement of the MPC”. The policy implication of RBI’s latest action is easier to understand than the immediate trigger. This sends a clear signal that inflation is going to be a more significant policy challenge than growth for the Indian economy. The unscheduled surprise element also seems to suggest that RBI realises that the optics of fighting inflation — interest rate hikes might not be the most effective tool to fight inflation when a large part of it is being driven by a global surge in commodity prices — will be critical in shaping both inflation expectations as well as the larger perception about India’s economic policy.

While the MPC resolution has put up a brave face on the economy’s growth prospects, the increased burden on household loans is bound to put pressure on private demand. This will come as an additional headwind along with the inflation-driven squeeze on purchasing power, especially for the not so welloff. To put it simply, the economic situation will continue to remain volatile in the near-term.