There are little signs of economy overheating: Saugata Bhattacharya

Saugata Bhattacharya, external member of the monetary policy committee (MPC), discusses with Rozebud Gonsalves about the second-order impact of input costs, expected financial conditions after the new FCNR(B) deposit and external commercial borrowing (ECB) incentives, and the inflation-growth trade off. Edited excerpts.

With crude oil prices falling, would growth be better than the central bank forecast? If yes, then do you think that the need to hike rates is lesser?

Yes, RBI growth and inflation forecasts were based, among other assumptions, on crude oil prices averaging $95 / barrel, which, based on oil futures, now appear likely to be lower. However, disruptions in supply chains could persist for some time, and hence it is difficult to predict the extent of growth recovery in FY27.

The MPC minutes have said that second-order input cost transmission getting embedded in retail inflation will have to be monitored. What would be the first signs visible via data that would suggest visible impact?
Second order effects are likely to manifest in core (non-food and fuel) CPI components, particularly in underlying components (excluding precious metals), indicating the extent of higher input cost pass through to retail inflation. However, it is difficult to forecast second order effects of higher input costs, which will depend on demand elasticities, input substitution and other pass through variables.The RBI Governor’s statement noted a revised FY27 core inflation at 4.7%, up from 4.4% at the April review, and headline at 5.1%, up from 4.6%. Factoring in price trends in other components, it might be possible to estimate specific inflation components.

Are current financial conditions already restrictive enough that a rate hike is unnecessary?

Although the policy repo rate is currently only 15 basis points above the FY27 forecast CPI inflation, money market and short term interest rates remain higher. RBI has also maintained system liquidity at appropriate levels. In addition, the gap between the repo rate and longer term bond yields have also risen much beyond steady state levels. Although MPC quarter wise forecasts of CPI inflation peaks in Q3 FY27, close to the upper band of the target, underlying inflation remains much lower and there are little signs of the economy overheating.
Have conditions eased after the FCNR(B) and ECB packages? Would strong inflows from these schemes reduce the need for any future monetary tightening?
Prima facie, the expected foreign currency inflows will add to autonomous domestic liquidity if even some of the inflows are absorbed by the central bank to replenish its foreign currency reserves. However, financial conditions will depend on RBI’s system liquidity management.Can it be said that growth is a bigger concern for the RBI in the current scenario, especially since inflation is projected at 5.1% and the repo rate is at 5.25%?
At the time of the MPC review, there were risks to both inflation and growth. While high frequency indicators suggested continuing resilience, they indicated a loss of momentum. This was the reason FY27 GDP forecast was a lower 6.6%, compared to the then FY26 estimate of 7.6%.