Possibility of higher food prices spilling over to core haunts MPC

The likelihood of higher food prices spilling over to the core remains a key concern for the MPC, which met recently. Going forward, the Reserve Bank of India (RBI) is likely to continue stressing on ‘actively disinflationary’, states Emkay. It will maintain a wait-and-watch mode to assess multiple macro forces, both domestic and global. Minutes of the meeting reveal increasing divergence among members, even as most members continued to back a rate action pause and status quo on the stance. While the moderation in core inflation was universally acknowledged, the rising prevalence and persistence of food price shocks as well as possibility of a spill over to the core was highlighted as a concern. Dr. Patra felt that the actual output is presently running ahead of potential output, which makes it necessary to be vigilant on aggregate demand dynamics. On the other hand, Prof. Varma and Prof. Goyal stated that the country’s potential growth rate is now likely higher but India is growing below potential. Both highlighted some early warning signs of near-term growth likely slowing, thus warranting the need for a rate cut.

On the inflation front, there was unanimous recognition of moderation in core inflation. At the same time, there were some differing views on persistent food price shocks. Dr. Goyal acknowledged higher food prices but noted that the better monsoons and improving supply chains are already helping prices to correct. She also mentioned that while household inflation expectations have risen, but the increase has been marginal. In contrast, Dr. Ranjan stated that such persistent price pressures cannot be ignored due to heavy share of food in household consumption and the risk of spill over to core inflation. The RBI Governor Shaktikanta Das has maintained the same argument, while Dr. Patra asserted that food inflation is now taking longer to revert to the trend after-shocks, thus negating any gains from core disinflation. In fact, Dr. Patra made a forceful argument that persistently higher prices are always a reflection of excess demand, even if the initial price spike has been caused by a supply shock.

He stated that the monetary policy needs to bring down the aggregate demand to the level of supply even in such situations, thereby making the most hawkish case for a rate pause. There were some comments on real rates, once again with differing inferences. Prof. Varma continued to assert that a projected real rate of 2.1 per cent remains too high – with 1.5 per cent being sufficiently restrictive, thereby calling for rapid cuts of at least 50 bps. Prof. Goyal had a similar estimation of the projected real rate; however, she referenced the low core inflation trend and slowing growth in stating that these conditions imply that real rates are higher than the neutral rate, and cuts are needed. On the other hand, Governor Das called the use of theoretical neutral rates to inform policymaking into question, especially when inflation is still higher than the target.