War-induced galloping inflation said to have forced MPC’s hand

An unexpectedly rapid surge in ‘war-induced inflation’ in March and April forced the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) to hold an emergency off-cycle meeting this week and announce the first repo rate increase in more than three-and-a-half years, people familiar with the central bank’s thinking said.

The inflation print for March, which was announced on April 12 four days after the MPC had concluded its first policy review of the new fiscal year, had ended up 50 basis points higher than the RBI’s forecast at almost 7% and with the reading for April expected to be even higher, it became imperative for the MPC to meet urgently to take timely action, the people, who spoke on the condition of anonymity, explained.

The RBI’s daily monitoring of data had also begun flashing warning signals with prices seen to be on a continuous and faster-than-anticipated uptrend, necessitating the urgent action, they said.

Indonesia’s unexpected decision to completely ban exports of palm oil had also added to the concern, the people said.

Any further delay could have turned counterproductive as the Indian economy has no capacity to withstand a larger rate increase, say of 150-200 bps, they added.

  
With the RBI detecting signals that there could be a nasty inflation surprise on May 12 — when the April CPI data are expected to be released — it decided to space out its policy response, the people said.

 
Going forward, the RBI aims to reverse its previous pandemic-triggered rate moves in small steps, much the same way it had reduced rates during the pandemic, they observed.

What has unsettled the RBI is the sharp acceleration in retail inflation, 75% of which can be attributed to the war. Prices of edible oil, wheat and even cattle and poultry feed are on a rise, adding to inflation. As per RBI data, prices of all commodities except for tomato and mustard oil are on a rise and the April numbers will be a ‘big shocker’.

Before February 24, the day Russia invaded Ukraine, the RBI had projected FY23 GDP growth at 7.8%, which was scaled down 60 bps to 7.2% in the April MPC meeting. The war had also inflected a 120 bps increase in inflation trajectory from 4.5% to 5.7%. Going forward, the impact was likely to be more as the war was showing no signs of ending, the people said.

However, future monetary policy actions would be independently calibrated. The RBI’s thinking was ‘to cross the river by feeling the pebbles’ and if the opportunity arises, and if the tide changes and the war ceases, there would be no need to raise rates because the economy needs an accommodative stance, the people said.

While dealing with high inflation another crisis threatening the world economy was debt distress, with about 60% of emerging market economies in deep distress. Sri Lanka was just the tip of the iceberg, the people opined, adding that there was apprehension that more countries could follow.

Cautioning that the emerging markets crisis could pose a risk, especially at a time when the RBI was gearing up to fight inflation almost single-handedly, the people stressed that the central bank would aim to do everything within its monetary policy powers to deal with the situation.