Clipped from: https://www.financialexpress.com/opinion/hike-in-policy-rates-unlikely-in-june/4254630/
As the West Asia conflict pushes crude prices toward $100 a barrel, IndusInd Bank’s Chief Economist explains why the RBI’s MPC will likely hold rates in June before preparing the ground for future monetary tightening.
RBI June MPC Preview: Status Quo Likely for Now as Crude Nears $100 Amid Global Turmoil
Monetary policy in India is at an inflexion point, with the West Asia conflict and closure of Strait of Hormuz keeping crude oil prices trading near $100 a barrel for the third month now. As a result, inflationary pressures are building up with rising input costs and higher fuel prices.
Net FPI capital outflows and widening merchandise trade deficit continue to put pressure on the rupee, adding to the imported inflationary pressures. In this backdrop, the monetary policy committee (MPC) will deliberate upon the rising risks to both inflation and growth in its meeting next week. The baseline forecasts of the RBI on the CPI inflation trajectory and real GDP growth are likely to be revised considering the prolonged duration of the energy price spike and supply chain disruptions.
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A sub-par monsoon forecast by the IMD has also added an element of risk to the food inflation trajectory. Average headline CPI inflation was placed at 4.6% for this fiscal in the April meeting and it is likely to be revised upwards. Real GDP growth forecast of 6.9% may be revised downwards. The focus of the MPC will thus be on maintaining price stability and keeping inflation expectations anchored. Therefore, monetary tightening is on the anvil over the next three months, especially as headline and core inflation will cross the 4% target level. That said, in the June meeting, a continuation of a status quo on the policy rates along with retaining a neutral policy stance, is the most likely outcome.
The MPC can continue with its wait-and-watch approach for now. That would allow it the time to assess the evolving situation around West Asia with possibility of a deal between the US and Iran and the incoming data.
Importantly, considering that at the current juncture the economy is facing an adverse supply shock and the government has taken steps at supply management, any adjustment to aggregate demand and consumption needs to be done in a calibrated manner. That would help ensure that inflation remains within tolerance levels, without sacrificing growth significantly.
Moreover, while the headline inflation is going to rise above 5% over the next three-six months, core inflation is likely to remain below that level, especially when precious metals price inflation impact is removed from the core based on CPI excluding food and fuel. That suggests that demand conditions are unlikely to reinforce the supply side price pressures, and that the headline inflation is thus likely to remain below the upper tolerance level of 6% and not persistently breach it. A status quo at this stage thus appears more prudent, as the MPC looks to balance inflation control with support for growth.
From an exchange rate stability perspective, while higher interest rates help in conjunction with other policy measures to boost capital inflows and to curb non-essential imports, wider interest differentials do not necessarily help in isolation. For one, to support the rupee, an outsized hike of at least 50 bps is required, which would dent the growth momentum and may only provide short-term respite to the currency.
In fact, for a meaningful support, attracting net capital inflows is crucial for which maintaining a favourable growth differential vis-a-vis other emerging economies is a necessary condition. For another, a flexible exchange rate can help counter the adverse external sector spillovers.
In other words, a weaker rupee would help curb imports demand and help reduce the current account deficit. Moreover, in an inflation targeting regime, the impact of the exchange rate movements on the headline inflation determines the policy response. That necessitates remaining vigilant on imported inflationary pressures but avoiding abrupt and large interest rate increases to stabilise the exchange rate.
On balance, monetary tightening is now the next policy move, and the June MPC meeting is likely to prepare the ground for future rate hikes.
(The author is Chief Economist, IndusInd Bank.)
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.
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