The Reserve Bank of India's monetary policy committee (MPC) on Thursday left the benchmark repo rate on hold at 6.5 per cent. This is the third consecutive time that the central bank has left the key rate at which it lends money to commercial banks unchanged. The move comes amid a sharp spike in prices of vegetables like tomato, and RBI Governor Shaktikanta Das warned that a "substantial increase" in headline inflation would occur in the near-term.
The CPI (consumer price index) inflation had moderated to 4.6 per cent in the April-June quarter, well within the 2-6 per cent inflation band. However, it is now projected to surge to 6.2 per cent in the July-September quarter, a full 1 per cent higher than RBI's earlier projection of 5.2 per cent. This has been driven by a spike in prices of certain vegetables; tomato prices skyrocketed to Rs 200 a kilo. Prices of pulses have also increased.
As supply improves in coming months, vegetable prices are expected to cool. RBI projects retail inflation to track back to 5.7 per cent in the October-December quarter and 5.2 per cent in January-March 2024, according to its latest assessment. For the full year, RBI is expecting CPI inflation at 5.4 per cent, compared with the forecast of 5.1 per cent in the previous MPC meeting.
"Headline inflation projection for Q2 of 2023-24 has been revised up substantially, primarily due to the price shock from vegetables," said Das.
He said that given the likely short-term nature of these shocks, the monetary policy could look through high inflation prints caused by such shocks for some time.
"The frequent incidences of recurring food price shocks, however, pose a risk to anchoring of inflation expectations, which has been underway since September 2022," he said.
Uncertainties, also remain on domestic food price outlook due to sudden weather events and possible El Nino conditions in August and beyond, he added.
Das said that continued and timely supply-side interventions was critical to limit the severity and duration of such shocks and that it was necessary to watch emerging trends and risks to price stability.
"We have to stand in readiness to go beyond keeping Arjuna’s eye to deploying policy instruments, if necessary," he stressed.
He also reiterated that bringing headline inflation within the tolerance band was not enough and the need was to remain firmly focused on aligning inflation to the target of 4.0 per cent.
Amid near-term inflationary challenges, the MPC decided by a majority of five out of six members to remain focused on "withdrawal of accommodation" to ensure that inflation "progressively aligns with the target," while supporting growth.
Near-term inflation concerns apart, the Governor noted that India's economy is "exuding enhanced strength and stability despite the massive shocks to global economy in recent years."
While the grim prospects of a "hard landing" among major global economies appear to have receded, global growth is likely to remain low by historical standards in the current and next few years, noted Das.
The IMF recently raised its global growth projections for 2023 to 3.0 per cent from 2.8 per cent.
Amid slow global growth, world merchandise trade volume growth is expected to decelerate to 1.7 per cent in 2023 from 2.7 per cent in 2022, according to the WTO.
However, India is expected to withstand these external headwinds far better than many other countries, opined Das, who said aggregate demand conditions domestically continue to be buoyant.
Domestic air passenger traffic, passenger vehicle sales, households' credit, all indicate sustained growth in urban demand, he noted.
"High growth in agricultural credit and improving sales volume of major fast moving consumer goods (FMCG) companies suggest incipient recovery in rural demand, which will be reinforced by improving kharif prospects," Das added.
Investment activity has also gained further steam on the back of government capital expenditure, rising business optimism and revival in private capex in certain key sectors, he pointed. However, growth in services exports decelerated amidst slowing external demand.
In this backdrop, the RBI has retained its real GDP growth forecast for the current 2023-24 financial year at 6.5 per cent.
Even as the RBI has been focused on withdrawal of accommodation, level of surplus liquidity has gone up in the system in recent months on the back of return of Rs 2,000 denomination currency notes to the banks, RBI's surplus transfer to the government, pickup in government spending and capital inflows.
The RBI has left the cash reserve ratio (CRR) unchanged at 4.5 per cent. But, with effect from the fortnight beginning August 12, 2023, scheduled banks will have to maintain an incremental cash reserve ratio (I-CRR) of 10 per cent on the increase in their net demand and time liabilities (NDTL) between May 19, 2023 and July 28, 2023.
This measure is intended to absorb the surplus liquidity, said Das, adding that this is a temporary measure for managing the liquidity overhang. He also said that there will still be adequate liquidity in the system to meet the credit needs of the economy.
The I-CRR will be reviewed on September 8, 2023 or earlier with a view to returning the impounded funds to the banking system ahead of the festival season, he said.
