The Reserve Bank of India’s monetary policy committee (MPC) will meet for three days from June 4 to examine the direction of monetary policy and interest rates. While the April meeting did not result in a hike, an examination of the minutes of that meeting reveals that many members of the MPC are hawkish about interest rates. If the MPC decides on a rate hike in June, even if just to signal the intent of the RBI, it would be a welcome step; it should not be postponed to the August meeting of the MPC, as some analysts have suggested. The economy is clearly on a path of recovery and, as Deputy Governor Viral Acharya has pointed out, there is limited additional scope for accommodative monetary policy. While growth needs to be sustained and private investment needs to recover further, action on these fronts must come from repairing the investment pipeline and more work on easing the bad debt crisis in Indian banking, not from easy money.
Two features of the economy will be the focus of the MPC. The first is inflation. While in its target zone, inflation is currently above 4 per cent and inflationary pressures persist. Input prices are rising, and the path of food prices is subject to politically set formulae for the minimum support prices received by farmers. Inflation was 4.4 per cent in March and 4.3 per cent in February, yet core inflation remains a worry. The push to inflation from crude oil prices, which touched $80 a barrel recently, is of particular concern. The relevant ministers from Saudi Arabia and Russia met recently to address the overall reduction in crude oil supply that has been agreed upon by the large oil exporters, and although the price has begun to moderate, it is possible that the oil markets will remain at least moderately elevated. For India, that is a big concern. The increases in global oil prices have not been fully passed on to consumers, and this merely means that there is suppressed inflation in the economy. The impact on the government’s fiscal deficit of populism over oil prices, including a possible cut in carbon taxes, must also be taken into account. There is no room for overconfidence on the inflation front.
The second aspect of the macroeconomic situation that is relevant is the question of India’s external account. Debt outflows from India have progressed steadily in recent months. Foreign portfolio investors have sold $7 billion worth of stocks and bonds in the past two months. The global monetary environment is turning less accommodative. It is true that India is not as fragile as it was in 2013 and it has more foreign exchange reserves in hand now. Yet Indian policy makers would be hard put not to respond to this change. Thus a signal from the MPC is both necessary and important. A hike in the repo rate, even if only 25 basis points, will demonstrate that the monetary authority is watching this situation and is determined to ensure stability in capital flows as well as in the price environment.