Just days after the budget failed to give a demand boost, the
(MPC) has announced another pause in repo rate cuts, but kept its stance accommodative. It has provided some relief to loans for auto, real estate and
(MSMEs), and long term repo rates like at the European Central Bank (ECB). But with surging headline consumer price index (CPI),
has been forced to pause on the repo rate.
There is relief in the market because there was a worry that the MPC may turn hawkish, and even if it did not raise rates, it could shift its stance from accommodative to neutral.
Inflating Own Numbers
However, with core inflation coming down — and well inside the 4% target — and even
just under 6% for Q3 FY2020 (the outer range for the mandated inflation target), and no guarantee of a recovery in growth, there was no reason for the stance to change.
If anything, the MPC could have cut rates further, as its own inflation projections show a quick reversal to CPI inflation. The MPC has revised its inflation projections upward to 6.5% for Q4 FY2020; 5.4-5.0% for H1FY2021 and 3.2% for Q3 FY2021.
Given the long history ofexaggerated inflation projections by the MPC, which in the past have been used to keep average real repo rates at around 250 basis points — at least 100 basis points too high — how much faith can we have in these projections? With a bumper rabi crop expected, cereal and vegetable prices should come down.
Onion prices alone contributed 2.1 percentage points to headline inflation in December 2019. On balance, the MPC’s inflation projections again appear to be on the high side and are, in any case, temporary, as by its own projections, they drop rapidly to 3.2% by Q3 FY2021. The real risks to the economy are not temporary price surges in food and fuel, but general lack of demand.
This may kill any green shoots, which the MPC itself admits are muted. Capacity utilisation in manufacturing actually fell to 69.1% in Q2 FY2020 from 73.6% in Q1FY2020, passenger car and twowheeler sales are still down. Where there was an uptick, like in tractor sales and output of core industries, it was very small after many months of huge declines.
RBI projects 6% GDP growth. But even this modest target is no sure bet, and needs all the help from a coordinated fiscal and monetary policy. We see once again the MPC erring in placing too much emphasis on inflation and not enough on growth, given the skewed nature ofits mandate.
Given that the primary risk for India going forward is growth, not inflation, the CPI-based inflation target regime continues to be harmful. RBI governor Shaktikanta Das has been more pragmatic and consultative than his illustrious predecessors.
He has openly admitted in his statement, ‘Consequently, even though the present
decision is constrained by elevated inflation pressures, there are other ways in which RBI can strive to revive growth.’ He is clearly feeling hemmed in by the monetary policy regime.
Just Pass It On
And, on careful examination, there are not many options with RBI. Das’ statement largely focuses on painstaking efforts to induce banks to pass on previous rate cuts of135 basis points (bps), with the marginal cost of funds-based lending rate (MCLR) declining by only 55 bps between February 2019 and January 2020, and the weighted average lending rates by 69 bps for new loans and only 13 bps for outstanding loans.
This begs the question as to why constrain monetary policy to an unhelpful inflation targeting regime that does not distinguish between supplyside price surges and demand-led inflationary pressures that lead to sustained inflation.
With constraints on fiscal policy to boost growth, this could have been a good time to lower rates further by another 15-25 bps had RBI not been constrained by an unproductive inflation targeting regime. By keeping the stance accommodative, RBI has signalled that it is keeping its powder dry for now, and would be willing to cut rates at its April meet if inflation starts to decline.
It should, in the meantime, get banks to pass through previous rate cuts, and look for more ways to support growth. Inflation targeting emerged when there were widespread concerns on rising commodity prices spilling over into generalised inflation. That era is over.
Globally, the concern is now deflation, not inflation. We were a ‘Johnny come lately’ to this fad despite its unsuitability to India at this stage of its development. Time to rethink on it. For now, RBI has sent a signal back to the finance ministry that as instructed, it is indeed focusing on inflation. Back to you on reviving growth.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of
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