To pause or not to pause the rate, that's the question

In its scheduled bimonthly meeting on June 6–8, the Reserve Bank of India’s Monetary Policy Committee (MPC), which sets the repurchase rate, or REPO, the benchmark interest rate, will face the question of whether to pause again or not. The unexpected decision by the meeting on April 3-5 to continue the same RPO at 6.50 per cent was based on the February consumer price index (CPI)-based inflation, or retail inflation, at 6.44 per cent, declining from the January figure of 6.52 per cent.

The inflation data for each month on retail inflation, core inflation (excluding food and fuel), and wholesale price (WPI) inflation are available by the middle of the following month. That means the MPC, which meets once every two months, has to rely on inflation data from the earlier month of the previous two months.

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Accordingly, the June 6–8 meeting will base its decision on April inflation, as May data will not be available until around June 15. The best ‘guesstimate’ of all should be that of the RBI governor, who, in his speech on May 25 at the Confederation of Indian Industry Annual Session, informed the audience that “the retail inflation targeted by RBI could be lower than the 4.7 per cent recorded in April.” I reiterate the suggestion made in this column several times earlier that the MPC should consider holding the meeting in the second fortnight of the month.

The Finance Ministry’s report on the economy released last week refers to the softening of international prices in recent months due to anti-inflationary pressures adopted by the world’s central banks. India’s WPI inflation, after remaining in double digits for 18 months, decreased to a 33-month low of -0.9 per cent in April 2023, and retail inflation also declined to an 18-month low of 4.66 per cent in April 2023.

The RBI’s target is retail inflation of 4 per cent. Its falling trend is clear: January (6.52 per cent), March (5.66 per cent), and now April (4.66 per cent). Further, the April retail inflation is within the tolerance zone (4 per cent plus a margin of 2 per cent, taking it to 6 per cent).

A major reason has been the fall in the international crude oil price, which is a reflection of depressed demand stemming from monetary tightening measures. The benchmark Brent crude price fell from a high of $98.35 per barrel in March 2023 to $71.80 on May 19, 2023.

Secondly, India took full advantage of the Russian crude price fixed by the US at $60 per barrel as part of sanctions imposed against Russia for preventing Russia from funding its war against Ukraine using export earnings. India is allowed by the US and its allies to buy and refine Russian crude into various products for domestic purposes. The result is that Indian consumers have been experiencing low fuel-related inflation.

Thirdly, the European Union (EU), which had banned imports of crude from Russia, did not mind imports of refined products, including diesel, from India. The Netherlands has benefited from cheaper imports of petroleum products from India. The unhappy EU has called for a crackdown on India’s “re-selling Russian crude” on the grounds that it violated Regulation 833/2014, which prohibits re-exports of Russian crude. India rebutted that the EU’s Regulation 833/2014 makes it clear that “the crude, when substantially transformed in the third country, cannot be treated as Russian anymore”

No doubt, India, which was dependent on imports of crude to the extent of 85 per cent of its total requirements, has saved US dollars as its imports now account for 60 per cent of its requirements from Russia, reducing imports from oil exporting countries to 20 per cent. Furthermore, Russia and India have agreed to trade in rupees, avoiding settlement of payments in US dollars. With India’s balance of trade improving, the Indian rupee is not under pressure. As India’s macroeconomic indicators are now attractive, encouraging a greater inflow of short-term foreign portfolio investment, the foreign reserves once again
touched $600 billion on May 19, 2023, after nearly two years.

External factors

Though the declining trend in US inflation was also well pronounced, with the highest inflation of 9.1 per cent in June 2022 falling to 6.5 per cent in December 2022 and 6.0 per cent in February 2023, the Federal Reserve (the Fed) took a surprising decision on March 27. It raised the interest rate from 4.75 per cent to 5 per cent. The Fed gave the reason: “Inflation is still a major issue”. On May 4, there was yet another increase: from 5 per cent to 5.25 per cent, though inflation fell in April below March’s 4.9 per cent. The reasons cited were growth in wages and tightness building up in labour-intensive sectors.

In his press meet, the Fed chair dropped the much-dreaded R-word. He remarked, “…the case of having a recession, I don’t rule that out either. It is possible we might have a mild recession”. That made the oil-exporting countries nervous. Their fear is that crude prices might crash. They have prepared plans for cuts in output. On the other hand, optimism has been boosted by a likely successful resolution of the debt ceiling issue by the US Congress and the government within ten days. Further, the US has already announced that it will buy 3 million barrels to replenish its depleted strategic reserves. These developments would raise crude prices.

The latest disturbing news is from Germany, which is now in recession—it is confirmed as per definition, as GDP growth rates in two consecutive quarters (the last quarter of 2022 and the first quarter of 2023) are reported negative. The MPC has to decide whether to prolong or not to prolong the pause. It is aware that as growth and stability are dictated more by external factors, monetary policy has to play a cautionary role.

(The writer, a former senior economist of the Manila-based Asian Development Bank and a former professor of economics at Fiji National University, is currently an honorary adjunct professor at Amrita School of Business, Bengaluru.)