Second round of food price shocks? MPC members in wait-and-watch mode

Members of the monetary policy committee (MPC) decided to wait and watch the evolution of headline inflation during the August review of the monetary policy while advocating to look through price shocks since they are transitory in nature.

All the six MPC members voted to keep the policy repo rate unchanged at 6.5 per cent for the third consecutive policy review meeting, citing inflationary concerns, especially the spiralling prices of tomatoes and vegetables.

“Our task is still not over. Given the likely short-term nature of the vegetable price shocks, monetary policy can look through the first-round impact of fleeting shocks on headline inflation,” RBI Governor Shaktikanta Das said, noting that the headline inflation has softened from last year’s elevated level but remains above the target.

July inflation print, which was released after the policy review meeting, was a 15-month high at 7.44 per cent, above the central bank’s upper tolerance limit of 6 per cent.

Das said the RBI needed to be ready to pre-empt any second-round impact of food price shocks on the broader inflationary pressures and risks to anchoring of inflation expectations.

“We continuously assess the impact of our past actions, the implications of incoming data for the evolving inflation and growth dynamics and stand in readiness to act whenever necessary,” Das said.

The RBI governor said the central bank remained committed to aligning inflation with the 4 per cent target.

Deputy governor M D Patra emphasised on the need to ensure sustained easing of core inflation, which, he said, was crucial to the MPC’s objective of bringing inflation down to the target.

He said the commitment to price stability requires the RBI to see off price perturbations by guarding against spillovers.

“In India, food price flares can permeate through wages, rents, transport costs and, importantly, through expectations into core inflation,” he said.

Core inflation – CPI inflation excluding food and fuel – has fallen but still elevated at 4.9 per cent in July.

Patra highlighted the risk of liquidity overhang on inflation.

The RBI mandated banks to maintain a 10 per cent incremental cash reserve ratio during the August policy, which resulted in banking system liquidity turning into a deficit in the past few days.

“Withdrawal of excess liquidity should engage primacy in the attention of the RBI going forward as it presents a direct threat to the RBI/MPC resolve to align India’s inflation with the target, besides the potential risks to financial stability,” Patra said.

External member Ashima Goyal emphasised on diversified and resilient vegetable supply chains to negate weather related price shock.

She said Indian oil majors turned profitable in the summer last year and are showing large profits. “They are in a position to reduce domestic prices. Oil price cuts have a large impact on household inflation expectations.”

While commenting that it was appropriate for the MPC to pause, Goyal said she voted to continue with the stance on withdrawal of accommodation since present liquidity is still in surplus.

Another external member Jayanth Varma said a couple of very high readings did not call for panic as it was not the case for low inflation reading.

“What is important is the projected trajectory of inflation over the next several quarters. On this basis, I continue to have the same cautious optimism that I had in the June meeting,” Varma said.

He said the current level of the repo rate was high enough to bring inflation below the upper tolerance band on a sustained basis and also glide it towards the middle of the band.

Varma, the only member who voted against the withdrawal of accommodation stance, said the disconnect between stance and action “has completely hollowed out whatever meaning the stance might have originally had, and turned it into a harmless ritualism.”

The next meeting of the MPC is scheduled on October 4 and 6.