Factors influencing RBI’s monetary policy stand

Source-This post Factors influencing RBI’s monetary policy stand has been created based on the article “MPC’s cautious approach is driven by inflation” published in “The Indian Express” on 8 June 2024.

UPSC Syllabus-GS Paper-3– Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context-The article discusses the monetary policy stance of the Reserve Bank of India (RBI) and the factors influencing its decision-making, particularly in relation to inflation targeting and economic growth.

Provisional estimates from the National Statistical Office indicate strong GDP growth in India, at 8.2%, surpassing expectations. This growth allows the RBI’s Monetary Policy Committee (MPC) to concentrate on reducing inflation to its target of 4%. The RBI has maintained its inflation forecast for the current fiscal year at 4.5%. Central banks, including the RBI, remain cautious due to inflation concerns.

How does the global rate hike cycle affect central bank moves?

The global rate hike cycle has reached its highest point. Central banks’ actions are likely to be out of sync, unlike the coordinated rate cuts seen during the Covid-19 pandemic.

The MPC’s decisions are not influenced largely by the monetary policy actions of systemically important central banks like the Federal Reserve (Fed) and the European Central Bank (ECB).

Read more- Inflation Management in India

What are the factors influencing RBI’s monetary policy stance?

1) Inflation Dynamics– Consumer inflation in India is mainly caused by the ongoing supply shock in agriculture, which has led to high food inflation. Core inflation, which excludes volatile food and energy prices, was at a low of 3.2% in April, remaining stable for several years

2) Lessons from the Post-Pandemic World-A key lesson for central banks is to pay attention to supply shocks, especially during periods of strong economic growth. When growth is robust, the MPC tends to prioritize controlling inflation, even if it’s due to a supply shock.

3) Food Inflation and Inflationary Expectations- Food prices, especially for vegetables, have stayed consistently high, with a 27.8% increase in April. Since food carries a significant weight of 39% in the Consumer Price Index (CPI), continued high prices can raise expectations of inflation and cause a widespread increase in prices. Bad weather and pests have made vegetable prices more volatile and increased their level.

4) Commodity Prices – Lower commodity prices have reduced costs for businesses, thus keeping core inflation low. However, increased uncertainties in the Middle East have pushed up prices of essential commodities like oil and gold. If this continues, along with a low-base effect, it could raise core inflation significantly this fiscal year.

5) Economic Growth – The National Statistical Office raised the fiscal 2024 growth estimate from 7.6% to 8.2%. Recent data, like record GST collections, strong Purchasing Managers’ Index (PMI) readings, and robust credit growth, indicate a strong start to this fiscal year. Additionally, the RBI increased its GDP growth forecast for this fiscal year to 7.2%.

Thus, there is a need to strike a balance between promoting growth and managing inflationary pressures, particularly those arising from supply-side shocks in the agricultural sector.

Question for practice

What are the factors influencing RBI’s monetary policy stance?