The RBI monetary policy committee should now pause rather than focus on further tightening, says RBI MPC member Jayanth R. Varma in the minutes of the monetary policy meeting held last month.

A pause is needed after this hike because monetary policy acts with lags, Varma says, adding it may take 3-4 quarters for the policy rate to be transmitted to the real economy, and the peak effect may take as long as 5-6 quarters.

"It is dangerous to push the policy rate well above the neutral rate in an environment where the growth outlook is very fragile. While the level of economic output has recovered to pre pandemic levels, it remains well below the pre pandemic trend line. Tightening global financial conditions and recessionary fears in advanced economies are acting as drags on the domestic economy as well. Weakening export growth means that economic growth has to be driven by domestic demand which is still not sufficiently robust. Much of the hope for economic growth rests on the possibility of a revival of private investment in response to rising capacity utilization. We should be careful to ensure that an unreasonably high real interest rate does not thwart this much needed upswing of the investment cycle," Varma says.

Much of the impact of this large monetary policy action is yet to be felt in the real economy, according to Varma.

Less than a third of the increase in the repo rate during April-August has been transmitted to retail bank deposit rates, explains Varma. Bank deposit interest rates play a critical role in stimulating savings, dampening consumption demand, and thereby mitigating inflationary pressures. "We should hopefully see more of this transmission in ensuing quarters. While there has been much higher transmission from policy rates to lending rates, the transmission from lending rates to the real economy would also take time," he says.

Meanwhile, RBI governor Shaktikanta Das says the future trajectory of inflation remains clouded with uncertainties arising from continuing geopolitical conflicts, possibility of further supply disruptions, volatile financial market conditions and domestic weather related factors.

Headline inflation remains elevated and above the upper tolerance band of the target. As per current projections, headline CPI is expected to moderate to 5.8% in Q4 of 2022-23 and further to 5.0% in Q1 of 2023-24, the RBI governor says.

"The world is in the eye of a new storm originating from aggressive monetary policy tightening and even more aggressive forward guidance from advanced economy (AE) central banks. This has resulted in a tightening of global financial conditions, extreme volatility in financial markets, risk aversion among investors and sharp appreciation of the US dollar. Such market turmoil on top of globalisation of inflation and deglobalisation of trade has hugely negative consequences for emerging market economies," says Das.

Even in advanced economies, the narrative is increasingly shifting from stagflation to possible recession. These developments are taking place even as the world is still grappling with the shocks from Covid-19 and the conflict in Ukraine.

The Indian economy is obviously impacted by the unsettled global environment, says Das, adding that there are pronounced consequences not only for our domestic inflation and growth dynamics, but also financial markets.

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