RBI should tread carefully in the first half of 2018-19

Not going hawkish is out of fashion these days. But, when the Reserve Bank of India (RBI) is not hawkish on growth, inflation and interest rates it is considered a positive for resilience in the economy that is going through major structural adjustments. Inflationary concerns seem to have consumed the multi-member Monetary Policy Committee (MPC) headed by RBI governor Urjit Patel that met for the first time post budget presentation on February 1. Post-budget meetings at RBI are usually marked by light banter about “what went wrong and what would work” in the proposals outlined in the budget. Especially during Pranab Mukherjee’s days at North Block, one could not miss the ebullience with which the RBI board of governors and monetary policy review were conducted. When it came to Palaniappan Chidambaram, the linkages with RBI were more formal and business like. With finance minister Arun Jaitley and RBI governor Patel at the helm, one could only expect a lot under the sun top be discussed.

Ever since the six-member MPC was constituted year before last, the way the RBI and finance ministry worked underwent a significant change. Wednesday meetings seem to have focused more on inflation and the ominous portents accompanying it. The single biggest challenge to keeping inflation at 4 per cent was the 50 per cent increase in minimum support prices (MSP) for all crops over comprehensive costs in tune with the MS Swaminathan Committee recommendations. Though the base prices would be computed in consultation with the states, more money in the hands of people would not only push up consumption but also exert pressure on retail inflation. This is bound to make things difficult for RBI to keep the inflation at 4 per cent plus or minus 2 per cent during the current fiscal.

The second big threat was the firming up of oil prices that would translate into higher petrol and diesel prices. Higher pay and house rent allowances for government, semi-government and public sector employees are yet another pressure point for RBI and finance ministry in keeping the inflation rates. Here again, higher spending would fuel inflation at retail level. On a parallel, an across the spectrum increase in customs duty on mass consumption products as part of the budget package will have its contribution to inflation expectations.

Higher commodity prices — both crude and agriculture products — in the international market coupled with improved consumption demand would also contribute to India’s inflation basket. Staggered deficit targeting at 4.5 per cent in the next financial year would have its own impact on both spending by the government and consumption leading to higher inflation that is bound to pinch the common man via higher interest rates and costlier items. In effect, the RBI has rightly pointed to return of high inflation and high interest rates days that need to be handled deftly.

Withdrawal of quantitative easing and normalisation of monetary policy abroad — read US — would also play a part in pushing up inflationary expectations at home. A combination of all these pressure points are bound to exert pressure on RBI policy panel to cut consumption demand even it means lower economic growth rates.

This seems to be the centrepiece of action on the RBI front while options before the MPC were very limited. Hence, maintaining a neutral stance on economic growth vis-à-vis inflation is a huge positive indicator while the growth expectations were kept at 7.2 per cent for next fiscal. However, the biggest issue before RBI will be to tread carefully during the first half of 2018-19 when the inflation is bound to head northwards to clock 5.1-5.6 per cent.