May 2022 MPC minutes mark RBI shift towards inflation control

In an unscheduled MPC meet on 04th May, RBI announced a 40 basis points rate hike from 4.00% to 4.40%. The rate hike was amplified with a 50 bps CRR hike, which will absorb Rs87,000 crore of surplus liquidity. However, the MPC held the stance as accommodative, while promising to work towards gradual unwinding. It must be noted that Dr. Rajiv Ranjan has been inducted into the MPC in place of Dr. Mridul Saggar.

The special MPC meet convened in May 2022 marked a drastic shift in the stance of the MPC. With the 40 bps rate hike, the RBI is setting the stage for another 75 bps rate hike in the next two policy meets. That would effectively unwind the entire COVID largesse. As is the practice, the RBI published the minutes of the May 2022 MPC meeting after a fortnight on 18th May. Here is the gist of the discussions of the 6 members of the MPC.

Shashank Bhide underlined that at the time of the April 2022 meet, the MPC only had access to February 2022 inflation data. However, subsequently, there was a sharp spike in both CPI and WPI inflation in March 2022, which got accentuated in April. Global supply chain constraints due to the Russia war and China lockdown were aggravated by the edible oil export ban imposed by Indonesia. The net impact of all these events was a sharp spike in imported inflation.

Bhide has also pointed out that the growth indications from the high frequency indicators like PMI, GST collections and e-way bills were positive. However, it must also be noted that a lot of the GDP growth has been driven by exports and that is a function of high commodity prices. Hence, growth was recovering but still dependent on the commodity cycle. To curb inflation aggressively, Bhide voted for a 40 bps rate hike. He also voted to continue the accommodative stance, while applying other measures to absorb excess liquidity.

Goyal sees the need to hike policy rates as necessary to pre-empt second round shocks from rampant inflation. She has pointed out that in the past food and oil price inflation have demonstrated serious second round effects. She pointed out that multiple shocks had led to inflation staying above the tolerance limit for too long now. In fact, inflation has been above the 4% mark for a number of years. These challenges can be addressed via a rate hike.

Goyal highlighted that the sharp rise in inflation in recent months had hit consumers. Hence, it was likely to have an impact on inflation expectations and push up inflation further. One way to pre-empt such a downstream effect is to front-load rate hikes so expectations on inflation are curbed. Goyal also focussed on the need to have a surprise effect in rate policy shifts, to avoid too much of overreaction. Goyal voted for a 40 bps rate hike and calibrated continuation of accommodative stance.

Jayant Varma pointed that the forward guidance given by the MPC on accommodation had been the roadblock to rate hikes in the past. However, with the RBI withdrawing the forward guidance in April 2022 MPC meet, the question was not whether but when the rate hike would actually happen.

Varma highlighted that while the MPC had rightly prioritized accommodation at the height of the pandemic, it was behind schedule on raising rates. Ideally, Varma would have preferred a 50 bps rate hike with another 50 bps in June 2022, but decided to go with the consensus of 40 bps rate hike, instead of dissenting. However, Varma underlined the need to move faster as inflation had already risen more than the 40 bps rate hike.

According to Dr. Rajiv Ranjan ( who was inducted into the MPC in place of Mridul Saggar), the big change in 2022 is that the MPC is no longer treating inflation as transitory. That was the stance through 2020 and much of 2021. With growth normalizing, the focus had to shift back to inflation control. However, the logic of the 40 bps rate hike was not clear.

Dr. Ranjan has justified a higher than 25 bps rate hike to anchor inflation expectations to more rational levels. However, he also reminded that the actual impact would be much higher since the RBI had decided to amplify the 40 bps rate hike with a 50 bps CRR hike. The 50 bps CRR hike is expected to soak up much of the surplus liquidity.

Patra has made in important point that stagflation (tepid GDP growth plus high inflation) has from an outlier scenario to a baseline scenario. Patra warned that continuing to hold rates at low levels would mean inflation continues to rein high. That is because the inflation is imported and caused by extraneous factors like the war and global supply bottlenecks.

Patra highlights the risk of diverging from the US Fed on hawkishness. Such divergence poses a big challenge for Indian markets and for other EMs. Weak growth, high inflation and low rates create a negative real rates scenario and could trigger massive capital outflows. FPIs have already pulled out Rs2.10 trillion from India since October 2021.

While the RBI governor, Shaktikanta Das, did not have to cast a deciding vote he did make an important point. According to Das, in a dynamic and fast changing environment, it was essential to be flexible and fleet-footed in monetary action. According to Das, the trigger for this unscheduled rate  hike was not just headline inflation but the inordinate stickiness of core inflation. Das added that the broad recovery in contact-intensive sectors gave room to RBI to front-end monetary hawkishness.

What are the big takeaways? Firstly, this is the end of accommodation in any form. RBI will now take inflation head-on, above all else. Secondly, the RBI does not see early resolution to supply chain bottlenecks, which is the key factor driving imported inflation. Lastly, the RBI has opened the doors for two phases of rate hikes. While phase 1 will focus on getting repo rates back to pre-COVID levels; beyond that, phase 2 would be at the discretion of the RBI. It is now over to the RBI!