Balancing Inflation Control
Where the cost is the price of money.
Will interest rates come down soon? Will the RBI pause hiking rates? These questions surfaced after the Reserve Bank of India recently released the minutes of the last Monetary Policy Committee meeting held on February 6-8, 2023.
The six-member panel of RBI on February 8 raised the policy repo rate by 25 basis points to 6.50%., with four members raising in favour of the hike and two opposing it stating that rate hikes would stifle economic growth.
In this battle between controlling inflation and promoting economic growth, the RBI appears, for now, to be leaning more towards controlling inflation. It is the ‘stickiness’, as RBI Governor Shaktikanta Das called the stubbornness of inflation, that the central bank is concerned about.
Interest rate is a key monetary policy tool to keep inflation in check. Central banks tend to raise rates to cool off demand and cut inflation, and cut interest rates to stoke demand.
Why does the RBI have this worry about inflation?
Because of geopolitical tensions (read Ukraine-Russia war and giant balloons flying over the US and Canada being shot down), volatility in the global markets, the yo-yo movement in crude oil prices, rising commodity prices, and weather-related events.
Adding heft to these concerns was the statement by a key RBI official that the monetary policy stance would be disinflationary till inflation is returned to target.
What is RBI’s inflation target?
It is +/- 4%. That is 6% on the upside and 2% at the bottom.
Where is inflation now?
It is at 6.52%. That’s way above the target level.
What will make inflation sticky?
India is the world’s third-largest consumer of crude oil consumer and has to import 85 % of its needs. Only two other countries import more crude oil than India.
The International Energy Agency expects the world’s oil consumption to rise by 2 million barrels a day in 2023, led by China’s economy reopening and a fall in Russia’s output.
This along with lingering concern over supplies and the strong pricing power of the Organization of the Petroleum Exporting Countries due to low inventory could keep oil prices up.
That does not sound nice to a country like India.
Turning up the heat
The government has launched an unprecedented effort, involving multiple departments, to protect the country’s wheat output, a winter crop, which is at high risk of being destroyed from the expected heat waves, to address the issue.
A heat wave in March last year, when temperatures soared to record highs, led to a 2.5% fall in wheat production. This led to the government banning wheat exports, which are still in place, to control prices.
The states that could experience a heat wave this time are Haryana, Punjab, Rajasthan, and Uttar Pradesh, the wheat bowls of India. Another fall in wheat output could cause prices to spike and impact inflation.
Another factor that could impact agriculture is the possibility of El Nino, an event that could occur according to some meteorological agencies.
El Nino is an abnormal warming of the surface waters in the eastern tropical Pacific Ocean, which has coincided with 60% of all droughts in India in the past 130 years.
However, it should be borne in mind that not every El Nino has caused a drought in India.
So, what does the country’s largest bank think the way ahead will be?
Media reports quoting the State Bank of India’s economist said rate hikes will either pause or be of a lower magnitude. This is based on an in-house interest rate skewness index which indicates that the space for further rate hikes looks low.
But with 4 of 6 Monetary Policy Committee members ruling in favour of a rate hike last time, it appears that tight liquidity and higher rates could be the way ahead.
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