Both dovish and hawkish

The first Monetary Policy Committee (MPC) meeting for the new fiscal year has kept the policy rate unchanged at 6.5% and retained the stance of monetary policy as focused on the withdrawal of accommodation. It has also not made any changes to the inflation and growth forecasts made in its February meeting. RBI believes India’s GDP growth rate and benchmark inflation rate, as measured by the Consumer Price Index (CPI), to be 7% and 4.5%, respectively, in FY25. This means that the Indian economy is likely to retain its goldilocks environment of low inflation and high growth in the current fiscal year as well.
Does this make Friday’s MPC a non-event as far as monetary policy is concerned? It would have been the case, had Governor Shaktikanta Das not given the inflation elephant “appears to be returning to the forest” analogy in his statement released with the MPC resolution. Compared to his past MPC statements, where he underlined the importance of inflation returning to the 4% target and not just the 2%-6% range, this is the first sign of RBI pivoting towards a dovish stance even if only in rhetoric. Given the fact that core inflation (non-food non-fuel) fell close to its lowest-ever levels in February, the dovish tilt in Das’s statement recognises the big picture on inflation.
Does it mean that a reduction in rates is now a possibility that will happen sooner rather than later? Analysts are advocating caution on this front and think that the central bank is likely to wait for more clarity on the 2024 monsoon and its impact on food inflation before eventually bringing down interest rates. After all, it is food inflation that has kept the benchmark inflation rate above RBI’s target of 4% and its prospects are linked more to climatic conditions than the non-farm part of the economy.
That RBI’s inflation targeting strategy has become so wedded to food prices, and by extension climate events, is a complicated policy challenge for the Indian economy. With the climate crisis worsening, extreme weather events and their adverse effects on food production will only become more common. There is very little monetary policy can do to manage food inflation and therefore, it is unfair if it is held accountable for inflation overshooting the target even if it is being driven by food prices.
The current growth momentum of the economy has given some policy buffer to RBI in keeping interest rates high and (potentially) erring on the side of caution. Das’s statement says this explicitly. However, this might not be the case whenever food inflation-driven tailwinds pull the overall inflation rate above RBI’s inflation target. In that case, the economy would have to sacrifice its growth potential.
To be sure, part of this problem is a result of the delay in updating the CPI basket which is still based on the 2011-12 Consumption Expenditure Survey (CES). Summary stats from the 2022-23 CES show that the share of food spending in the overall consumption basket is likely to fall significantly from its current value of 39%. Once the new CPI series reflects this changed reality — it will require at least one more CES result to check whether the 2022-23 numbers are statistically robust — food inflation-driven tailwinds for overall inflation are likely to weaken than what they are now.