Amidst creeping inflation and a falling rupee, it would seem that the Monetary Policy Committee (MPC) was left with little option but to hike the repo rate by 25 basis points. India is not anywhere near the situation it faced in September 2013 when taper tantrums roiled the rupee and led to FIIs rushing for the exit door, but there are some troubling similarities. FIIs have been net sellers in recent months, exiting out of emerging markets to the safety of the dollar, with the Euro Zone decelerating and exhibiting signs of financial instability. Meanwhile, the US is normalising its monetary policy. If FII outflows have created pressure on the rupee, rising crude prices have added to it. A 12 per cent rise in oil prices since the last MPC meet in April to $76 a barrel has played a role in pushing the rupee down by 5 per cent since its January value, to ₹67 today. It is notable that the rupee and the Indonesian rupiah have been among the worst-performing Asian currencies. Meanwhile, Moody’s ‘external vulnerability index’ — the ratio of short-term debt, maturing long-term debt and NRI deposits over a year to forex reserves — has been valued at 74 per cent in the case of India and 51 per cent in Indonesia’s case. With exports growing by just 3 per cent, and imports at over 10 per cent, the MPC needed to take steps to restore confidence in India’s external account. However, in future, the Reserve Bank could consider other ways to manage rupee demand, such as a forex swap window for oil companies.
It is clear that in an inflation-targeting arrangement, the MPC cannot be seen to be taking a lax view of rising prices. Hence, it has taken cognisance of the fact that projected inflation at 4.7-4.8 per cent for the remaining part of this year is above its medium-term target of 4 per cent. However, it is intriguing that the MPC chooses not to invoke its mandated 2 per cent elbow room, at a time when greenshoots of growth are making their appearance. Indeed, inflation numbers for the better part of this calendar year need to be discounted for their base effects. It is hoped that the MPC, after raising rates this time, gives due consideration to growth in its subsequent assessments. With 10-year benchmark yields already ruling above 7.5 per cent, a further hardening of rates can make access to credit that much harder for MSMEs in particular. The MPC should not lose sight of the fact that inflation that is cost-push in nature can co-exist with a situation of demand constraint.
However, the RBI’s move to ease credit terms for now to MSMEs not registered under GST is laudable. A balanced approach to growth, inflation and fiscal consolidation can see India through periods of turbulence.