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‘Slowing growth more worrying than inflation’ — why 2 members of RBI panel opposed repo rate hike

While saying that higher interest rates affect growth more than inflation, the two members said raising rates further could result in 'unacceptably low' growth in 2023-24.

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New Delhi: While a majority of the members of the Reserve Bank of India’s Monetary Policy Committee (MPC) voted in favour of its 8 February decision to hike the repo rate by 25 bps (basis points) to 6.5 per cent, two of them voted against it, citing slowing growth as a major concern, minutes of the meeting released by the RBI on Wednesday show.

The MPC has six members and each of them votes on what decision the committee should take regarding the repo rate. The repo rate is the rate at which the central bank lends to commercial banks and influences the rate at which these commercial banks lend to their borrowers. The conventional belief is that a higher repo rate helps in pushing inflation down, but also slows economic growth.

During the MPC’s meeting in August 2022, all six members voted unanimously to increase the repo rate by 50 bps. Just six months later, the tide seems to have turned, with one-third of the members voting against even a lower rate hike of 25 bps. 

If even one more member joins the ranks of those voting against a rate hike in the April 2023 meeting, that means half the MPC will be more worried about growth than inflation. This, of course, assumes that the current dissenters will continue with their current stance. 

With retail inflation in January coming in at 6.52 per cent, once again higher than the RBI’s 6 per cent upper comfort limit, there is a chance that MPC members may again re-evaluate their positions. Currently, however, the minutes of the February 2023 meeting show MPC members Ashima Goyal and Jayanth R. Varma were quite vocal about their concerns over slowing economic growth rather than persistent inflation. 

In fact, Goyal even pointed to the fact that increasing interest rates in an attempt to curb demand and thus reduce inflation actually has a larger impact on slowing growth than it does on easing the rise in prices.

Also Read: ‘Need to see a decisive moderation in inflation’: RBI Governor on 25 bps repo rate hike

Why did two members dissent?

“Although global growth prospects have improved, a slowdown continues in advanced economies,” Goyal said during the meeting. “Indian exports are showing signs of strain. The Indian PMI (Purchasing Manager’s Index) for new export orders fell to 51.2 in January from 53.4 in December. PMI has also softened for both manufacturing and services although it remains well above 50.”

“There are still only early signs of a revival in private investment, which has yet to come out of a decade-long slowdown,” she added. 

“The RBI consumer confidence survey shows while consumer confidence is recovering, it is still below 2019 levels.”

On the other hand, she argued that while inflation at the time (the January data had not been released by then) was easing, there were several non-monetary policy measures that could be used to further ease the inflation burden. 

“It may be time, however, for some more excise tax cuts as multiple supply shocks have imparted persistence to inflation,” Goyal added. “The large commodity component in India’s consumer price basket, and pockets of supply constraints, respond better to fiscal action. Our government has used such action very effectively in the pandemic period.”

Fiscal actions refer to steps taken by the government while monetary actions are those taken by the central bank. An example of such fiscal actions could be reducing fuel prices, she said.

“A pass-through of the persistent softening in international oil prices could help to counter adverse effects of global uncertainty and reduce inflation expectations,” she explained.

The prices of petrol and diesel have remained unchanged since 22 May, 2022.

Complacent about growth

Varma, the other MPC member to vote against the rate hike, said that monetary policy in the second half of 2021-22 was complacent about the risks of rising inflation, which led to the high levels of inflation seen in 2022-23. 

Now, however, monetary policy is erring on the other side, he said.

“In the second half of 2022-23, monetary policy has, in my view, become complacent about growth, and I fervently hope that we do not pay the price for this in terms of unacceptably low growth in 2023-24,” Varma warned.

“I believe that the 25 basis point rate hike approved by the majority of the MPC is not warranted in the current context of diminished inflationary expectations and heightened growth concerns,” he added. 

In her statement, Goyal, too, said that front-loading rate hikes — as the RBI seems to be doing with six consecutive rate hikes of 250 basis points since May 2022 — carries the risk of over-shooting in the Indian context.

“First, raising real policy rates to reduce demand has a stronger effect on growth than it does on inflation,” she said. “Second, since there are more lags in monetary transmission in India, over-shooting can have persistent deleterious effects here, including instability.”

Third, she said, macroeconomic stability improves most rapidly if real interest rates are kept below growth rates. 

(Edited by Geethalakshmi Ramanathan) 

Also Read: Rising wheat & milk prices, high core inflation: Why RBI’s rate hike cycle is unlikely to pause


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