Front-loaded rate hikes reduce need for action later, says RBI deputy governor Patra

MUMBAI: Reserve Bank of India deputy governor Michael Patra said that the front-loading of interest rate hikes to tame inflation will reduce the need for subsequent increases. In the near term, however, he said the inflation trajectory depends on geopolitical developments, global commodity prices, and global financial market developments.
“Our role has undergone a transformation in recent years. From lenders of the last resort, we have become defenders of the first resort. Hence, our response to inflation shocks such as the one we face today has to be predicated on managing expectations and fortifying credibility. If credibility is high and the shock is transitory, inflation returns to equilibrium without the need for any monetary policy action,” said Patra. The deputy governor was speaking at the SAARCFINANCE Seminar hosted by India on August 24, 2022, at New Delhi. A copy of the speech was released by the RBI on Friday.
RBI has forecast inflation at 6.7% for the current financial year with the growth in the index easing to below 6% only in the fourth quarter.
The deputy governor’s comments appear to indicate that the pace of rate hikes need not be uniform until the target is achieved. “Repeated supply shocks – which we are encountering now – trigger second-round effects through cost pushes, expectations, exchange rate and demand channels, warranting pre-emptive monetary policy action,” said Patra. According to the governor, even if the RBI has achieved credibility in its ability to tackle inflation, monetary policy cannot look through the second-round effects of repeated supply shocks. “If the inflation target is breached for a prolonged period, this could unsettle expectations and eventually get reflected in higher inflation. Higher credibility can reduce – not substitute for – the monetary policy response to second-round effects of repeated supply shocks,” said Patra.
“Our experience is that by frontloading monetary policy actions, credibility is demonstrated by showing commitment to the inflation target. Another dimension of monetary policy credibility is the timing of its response. A delay in the monetary policy response leads to a further loss of credibility, unhinging of inflation expectations and eventually, higher inflation outcomes with a higher sacrifice of growth,” said Patra.