Focus on supporting growth while keeping an eye on growing inflationary pressures prompted the Monetary Policy Committee (MPC) to hike key policy rates by 40 basis points by unanimous decision, shows minutes of the surprise meeting released today.

Waiting for a month till the next scheduled MPC meeting in June would have meant losing much time as war-related inflationary pressures accentuated, says Reserve Bank of India (RBI) governor Shaktikanta Das in the MPC minutes.

The worsening outlook of inflation warrants timely action to forestall second round effects which could lead to unanchoring of inflation expectations, states the RBI governor.

In an off-cycle meeting on May 2 and 4, all six members of the monetary policy panel, including Das, had voted for increasing policy repo rate by 40 basis points to 4.4 per cent, while retaining the accommodative stance with focus on withdrawal of accommodation “to ensure that inflation remains within the target going forward, while supporting growth”.

The headline inflation print in April reached an eight-year high of 7.79%, while wholesale inflation increased for the 13th month in a row to a 9-year high of 15.08%. Meanwhile, analysts have been slashing growth projections for India as inflationary pressures grow.

“Core inflation is likely to remain elevated in the coming months, reflecting high domestic pump prices and pressures from prices of essential medicines. Renewed lockdowns and supply chain disruptions due to resurgence of Covid-19 infections in major economies could sustain higher logistics costs for longer.

These factors, coupled with the geopolitical situation, high commodity prices due to global shortages and export restrictions, and volatile crude oil prices, impart significant upside risks to the inflation trajectory set out in the April statement of the MPC, the minutes state.

Meanwhile, domestic economic activity is looking at brighter prospects on the back of the forecast of a normal southwest monsoon and sustained recovery in contact-sensitive services. Robust government capex improving capacity utilisation, stronger corporate balance sheets and congenial financial conditions are likely to uplift investment activity.

However, worsening external environment, elevated commodity prices and persistent supply bottlenecks, alongside volatility spillovers from monetary policy normalisation in advanced economies pose formidable headwinds to economic growth.

“Our monetary policy actions today aimed at lowering inflation and anchoring inflation expectations should thus help to strengthen the medium-term growth prospects of the economy and protect the purchasing power of the weaker sections of society. Given the highly uncertain situation, the incoming data and information would be constantly monitored to reassess the outlook and take necessary measures,” says governor Das.

Das further states that RBI will continue with liquidity withdrawal in a phased manner over a multi-year period in sync with monetary policy and macroeconomic developments.

RBI deputy governor Michael Debabrata Patra warns that stagflation could be transitioning from a risk scenario to a baseline scenario, turning the still raw scars of the pandemic will become even more excruciating to bear and more lasting. Meanwhile, all the symptoms of a generalised financial deleveraging have started to appear, which could be followed by “a cascade of emerging market crises”.

“Recent incoming data suggest that India’s macro-fundamentals, barring imported food and fuel inflation, are still intact and in sync with the recovery that has been tenaciously making its way through waves of the pandemic. Labour absorption in manufacturing and services is rising, capacity utilisation is improving and there are signs of new investment gradually coming in. Yet, the momentum of the recovery is still below full strength, warranting policy support,” states Patra.

Even though the MPC voted for a 40 basis points hike in policy rates, member Jayanth Verma professed a higher quantum of increase, but refrained from dissenting on the issue.

“It appears to me that more than 100 basis points of rate increases needs to be carried out very soon. My preference therefore is for a 50 basis points increase in the repo rate in this meeting. The majority of the MPC is in favour of 40 basis points for reasons which are not very clear to me.”

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