Should RBI adopt a more hawkish approach to control inflation?

As Ashok, a software engineer, was adding vegetables to his cart on a grocery delivery app, he couldn’t help but notice how eating healthy has been getting dearer over the years. The possible rate hikes on his home loan had been burdening his mind too. Even as he began wondering how much his salary should increase to keep up with rising prices, he was feeling thankful that he at least had a job while his company had laid off hundreds.

The multitude of emotions a typical middle-class person feels in the above scenario must have been weighing down on the minds of the members of the Reserve Bank of India (RBI)’s Monetary Policy Committee too as they gave their statement on October 6. The MPC decided to keep the policy rates unchanged; the repo rate would remain unchanged at 6.5 per cent and the bank rate at 6.75 per cent. The RBI also stated its intention to ensure consumer price index (CPI) inflation eventually falls within a tolerance band of +/- 2 per cent of the targeted 4 per cent, while at the same time supporting growth. The statement shows that the RBI is walking on a tightrope here.

Even while the headline inflation spiked to a 15-month high of 7.4 per cent in July and refused to come down to below the tolerance levels even in August, the RBI has kept the repo rate unchanged at 6.5 per cent since February. The question of whether the RBI should have adopted a more hawkish approach to control inflation emerges in light of the burden that rising vegetable prices are placing on the pockets of the general public. The question becomes more pertinent given that the economy posted a growth of 7.8 per cent year-on-year in the first quarter of FY 2023-2024.

However, even while the public remains blissfully unaware of the slowing momentum in global growth, the RBI seems to be wary of global headwinds hampering domestic growth. Growth concerns should be important to the layperson, as it has eventual implications on recruitment, salary hikes, and layoffs. While growth is necessary, should it be at the expense of rising living costs for the average citizen, is something the RBI might have been asking itself.

While it acknowledges that an unprecedented food price surge and its recurring incidence can make the trend persistent, time will tell how not hiking the rates is being ‘actively disinflationary’. As the RBI reiterates its commitment to sticking to inflation targets, without a clear path to achieve this, one wonders whether the RBI intends to walk the talk.

This also leads to a thought of whether the RBI decided that as the vegetable prices are expected to undergo correction, managing inflation may become a side issue, at least in the short term. Should more such food price shocks occur, the RBI seems to be prepared to take timely action. However, these actions could have been detailed to a better extent to assuage the public and to manage the expectations of businesses, borrowers, and investors.

As one contemplates whether the RBI should have raised the rates to combat headline inflation, one also becomes painfully aware of the impact rate hikes can have on an average borrower — be it a homeowner or a small businessperson. While this reason may not have particularly led to the decision to keep the policy rates unchanged, the borrowers for now can take a moment to appreciate the instructions given by the RBI in August prohibiting capitalisation of penal charges. As a measure towards strengthening fair lending practices, the RBI had directed that penal charges should not become penal interest.

Given the threat of persistently high headline inflation and supply-side shocks, the RBI has decided to remain focused on the withdrawal of accommodation.

Jayanth R Varma, Professor of Finance and Accounting, IIMA, had expressed his reservations on the stance. While the details of his reservations may be known when the minutes are released, one can observe from the minutes of the August meeting that he had warned in June against the RBI patting itself on the back for bringing inflation within tolerance levels, and that he had not voted in favour of the stance due to its disconnect from reality, while he maintained that the rates were high enough to bring inflation down.

The fact that the stance was not unanimously approved shows the complicated nature of the present circumstances.

It seems that the RBI will continue to do a balancing act, while it needs to be more proactive in managing inflation.

(Ranjith Krishnan is a Thane-based sustainability consultant, and Usha Ganapathy Subramanian is a Chennai-based practising company secretary).

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.