The decision of Monetary Policy Committee (MPC) to raise repo rate by 50 basis points (0.5 percentage) in its meeting today was a “no-brainer”. That it comes within just five weeks of an increase of 40 basis points in an off-cycle meeting in May’22 also does not appear to be a big deal. The real issue is – how it was caught off-guard despite all its assertions of ‘monitoring closely’ and fell behind the curve and can it catch up now? Here is a brief look.

The MPC meets every two months and takes a decision on setting the interest rate based on its view of inflation and growth, the primary objective being to keep inflation within 4% +/- 2% range. Even though the committee did not raise rates in its April’22 meeting, statement of that meeting had ominous signs. “With the broad-based surge in prices of key industrial inputs and global supply chain disruptions, input cost push pressures appear likely to persist for longer than expected earlier. Their pass-through to retail prices, though limited till now given the continuing slack in the economy, needs to be monitored carefully”. The outlook of sharp inflationary pressure also reflected in its projection for CPI inflation for FY23 which was revised upwards from 4.5% in Feb’22 to sharply higher at 5.7% just within two months in April’22. (The projection has been revised further upwards to 6.7% in today’s statement i.e., in another two months).

The April statement also says, “The MPC is of the view that global factors are imparting sizeable upside risks to the inflation trajectory and downside risks to domestic growth”. This means MPC anticipated a high likelihood of even 5.7% projection getting breached. So, today’s statement saying “Inflation risks flagged in the April and May resolutions of the MPC have materialised”, appears to be coming from an embarrassed MPC.

Yet, it chose not to act in its April meeting. Considering the collective wisdom of the committee, it is difficult to believe that it did not seriously think about raising the rates in April meeting. So, was there some kind of understanding that MPC would wait for some more time and government, in the interim, would take fiscal measures? And on the failure of the government to act on time and on sensing it is getting too late, an off-cycle meeting was called to mend its mistake? Government did act but it was on 21st May, more than one and half months after the April MPC meeting. It may be noted that government reduced excise duty on petrol and diesel, waived import duty on some raw materials and increased export duty on certain products to ensure better availability in domestic market to bring down inflation.

While MPC may deserve the benefit of doubt and conjectures in the delay in raising rates, it is difficult to justify lagging ‘behind the curve’ in liquidity withdrawal. As per MPC’s policy statements, excess money supply, as estimated by daily absorptions under liquidity adjustment facility (LAF), averaged Rs 8.6 lakh crore in Oct-Nov’21, which came down to Rs 7.8 lakh crore in Jan-Feb’22 and Rs 7.5 lakh crore in March’22. This stayed at Rs 7.4 lakh crore till 3rd May’22 and came down by any sizeable amount to Rs 5.5 lakh crore only during 4th-31st May, just after the MPC off-cycle meeting. This is a very slow pace of withdrawal and rapid reduction in money supply should have been a ‘no-brainer’. Even Rs 5.5 lakh crore is lot of money slushing around which needs to be brought down to Rs 2-2.5 lakh crore, the level which was maintained just before the pandemic began.

To be fair to MPC, hike of 90 bps in last five weeks gives an indication that it has come on its own now and would not hesitate to take tough measures. However, whether that would help beat the inflationary expectations and bend the inflation curve would have to be seen.

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