RBI must keep playing it safe

The last three years have shown why fiscal and monetary policy have to remain conservative and nimble, and why policymakers themselves have to be resolute. Last week, the monetary policy committee of the Reserve Bank of India (RBI) raised the interest rate by 0.35 percentage points to 6.25% and, according to its policy statement, “decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.” On Monday, data showed retail inflation in November cooling to 5.88%, the first time this calendar year that it came in under 6%, the upper band of RBI’s tolerance level, even as industrial output for October contracted by 4%, with manufacturing contracting 5.6%, and consumer-facing categories contracting by 13-15%. At first sight, the numbers make it appear as if inflation is under control, and growth under threat – prompting some analysts to call for a change in stance at MPC’s February meeting.

That is an accurate assessment, up to a point. Inflation is cooling (a trend evident in wholesale inflation data, which came on Wednesday, with the headline print of 5.85%, a 21-month low), and the central bank expects it to cool even further; and growth has come to face increasingly strong global headwinds in the past few months. But a closer reading shows core inflation remains high (and has been almost constant at the 6%-plus level), with food prices (which are seasonal) largely being responsible for the sharp dip in November inflation, both retail and wholesale. And as RBI governor Shaktikanta Das said while presenting the policy statement, “In a hostile international environment, the Indian economy remains resilient, drawing strength from its macroeconomic fundamentals …”. That, and the bank’s policy statement, which spoke of “firm” core inflation, presaged another interest rate increase, albeit a small one, in February – and Monday’s data has not done enough to change the outlook. Sure, a lot will depend on the December inflation print (which will come out in January and be the basis for RBI’s credit policy action in early February), and the actions of the US Federal Reserve, but the central bank’s eventual decision on moving into a neutral stance, indicating an end to the rate tightening cycle, will depend on its reading of core inflation.

The tone and tenor of the credit policy statement suggest that RBI expects to see this happening by the middle or the end of the next quarter. Which is where the resoluteness bit comes in – around the world, inflation has proved more sticky than estimated by analysts and policymakers and RBI should continue to play safe, even as it remains open to global developments that may require a quick reaction.

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