Sixth Bi-monthly Monetary Policy Statement, 2019-20: RBI should take a pause and watch the extent and duration of the recent rise in inflation

Let's look at MPC's outlook for inflation and output in the last statement released on Dec 5, 2019. 

The MPC raised its inflation outlook sharply for H2 of 2019-20 to 4.7-5.1 per cent from 3.5-3.7 per cent.  H1 2020-21 inflation was projected at 3.8-4%.

GDP growth for 2010-21 was revised downwards from 6% to 5%. 

At the time of the last statement, the October CPI number of 4.69% had been released - a sharp rise from the previous month's 4%. The sharp rise in the CPI was due to the surge in food prices, especially vegetables. In its December statement, the RBI felt that food prices will continue to rise but would soften by February 2020.  We have had a continued sharp rise in inflation since then - the December number came in at 7.35%.  However, core inflation - excluding food and fuel prices - is still below 4%.  December's number could well be outside RBI's projections.

On the fiscal front, the Budget for 2019-20 shows, at least in terms of projections, discipline. 

Against this background, the MPC in its statement to be released tomorrow should hold the repo rate at 5.15% and continue with its accommodative stance.

In December, I had argued that the MPC should reduce the repo rate to 4.85%.  I had argued then that even a rise in the inflation rate on a persistent basis to 5% should be accepted given the sharp and sustained slowdown in the economy - 8.3% in 2016-17 to a projected 5% in 2019-20, the persistent banking and NBFC crisis, and credit growth at a standstill. I continue to hold this view, and watch the extent and duration of the current rise in CPI inflation.

It has been suggested in some circles that the RBI's inflation central target should be raised to 6% (with a range of +/- 2%) from the current 4%. I don't share this view at this stage. One major benefit India has had over the last few years is inflation under control, partly as a result of an appropriate inflation target regime. Tolerating inflation in the region of 8% on a persistent basis would be a major negative on the economy.