Analysis | Why MPC must bat for growth

The RBI's Monetary Policy Committee is caught in the dilemma of high persistent inflation vs falling growth.

The Preamble of the Reserve Bank of India (RBI) describes the basic functions of the central bank as the following: "To regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth."

Whenever there is a public debate on the RBI’s growth vs inflation stance, this preamble is revisited and the central bank is reminded of its primary duty - maintaining price stability. However, a pandemic could change priorities.

Right now, the Monetary Policy Committee (MPC) is caught in the dilemma of high persistent inflation vs falling growth.

What should be its top  priority?

In the last monetary policy, the MPC retained the key rates and continued with the accommodative stance.

What does it mean? An accommodative stance indicates that the MPC is willing to ease the rates or at least stay on hold till the stance continues; a rate cut is ruled out. If one reads between the lines, in the last monetary policy review, the language of the monetary policy was tilted towards a growth supportive stance, rather than inflation.

RBI Governor Shaktikanta Das gave a clear signal to the markets that there is a possibility of more growth-supportive measures going ahead. Das emphasised the part that the central bank is willing to do whatever necessary to make sure enough liquidity is available in the market, using all instruments at its disposal.

However, to a question at the presser on whether the MPC has junked inflation targeting, Das said inflation targeting is the central bank’s primary mandate and the RBI hasn’t junked that responsibility. However, pandemic conditions warranted focus on growth, Das said.

That’s exactly the stance is likely going ahead—a pro-growth policy, probably giving the RBI’s much-hyped inflation fight a temporary miss.

Inflation risks remain

It is not that inflation has been brought under control. Price pressures remain high and sticky. The MPC now projects Consumer Price Index (CPI)-linked inflation at 6.8 per cent for the third quarter, 5.8 per cent for the fourth quarter of FY21 and 5.2 per cent to 4.6 per cent in H1 of FY22, with risks broadly balanced. Remember, the central bank’s mandate is to keep the inflation at 4 per cent midpoint of the target range. The band is 2 per cent to 6 per cent.

This target was set in 2016 when the MPC-1 came into existence. But, the MPC’s policy stance and the revised inflation targets do not gel well. The inflation targets have been revised up significantly.

Retail inflation may stay high because of the high food prices also. “While cereal prices may continue to soften with the bumper kharif harvest arrivals and vegetable prices may ease with the winter crop, other food prices are likely to persist at elevated levels. Crude oil prices have picked up on optimism of demand recovery, continuation of OPEC+ production cuts and expected to remain volatile in the near-term,” the MPC noted in the policy statement.

What is the logic in forecasting inflation above the target band, but retaining an accommodative stance?

One explanation could be that the MPC doesn’t have enough ammunition in its arsenal against inflation. As inflation in India is not a demand-side problem - something that can be addressed through monetary policy - it wants to focus on growth revival.

Falling growth 

The growth scenario is depressing. The RBI’s new GDP forecast at -7.5 per cent for the fiscal year is better compared to its earlier forecast of -9.5 per cent. The MPC has noted that the recovery in rural demand is expected to strengthen further, while urban demand is also gaining momentum as unlocking spurs activity and employment, especially of labour displaced by the COVID-19 pandemic.

These positive impulses are, however, clouded by a possible rise in COVID-19 infections in some parts of the country, prompting some local containment measures, the MPC has noted.

In other words, Das is optimistic that there is recovery in both rural and urban segments, but sustaining this will need policy handholding. This means that there is still no confidence on the part of the central bank about the growth situation. The real GDP growth is projected at 0.1 per cent in Q3 of FY21 and 0.7 per cent in Q4 of FY21 with risks broadly balanced.

What should the MPC do going ahead? Should it be overly worried about inflation or shift significantly to a growth supportive policy stance?

Every economist agrees that the present economic scenario is highly worrying. With two quarters of successive negative growth, the Indian economy is officially in a recession. The Indian economy was already facing slowdown even before the COVID-19 pandemic hit the country. The onslaught of the pandemic made things worse. The all economic activities came to a standstill since last week of March when the nationwide lockdown was announced. Supply chains were broken. Result was huge job losses and closure of small businesses.

According to economic think-tank CMIE, an estimated 21 million salaried employees lost their jobs by the end of August. “There were 86 million salaried jobs in India during 2019-20. In August 2020, their count was down to 65 million. The deficit of 21 million jobs is the biggest among all types of employment. About 4.8 million salaried jobs were lost in July and then in August, another 3.3 million jobs were gone,” CMIE said.

Job losses have disastrous effects on consumer confidence and spending patterns. When income losses mount, consumer confidence takes a hit. People postpone discretionary spending. When consumer spending is less, companies earn less and tax revenues suffer. Getting the economic growth back on track is the only solution to save jobs and kickstart the economic cycle. Reviving growth is thus the primary priority.

“Growth is the single most important issue,” said Harihar Krishnamurthy, Treasurer at Firstrand. “If you want employment, GDP growth, fiscal well-being etc you need big growth. So I would put growth up there,” Krishnamurthy said.

The government, logically, is worried about growth. According to a report, the government is considering a looser inflation target for the MPC that will give more room to the central bank to focus on growth. Even if the government goes for it, it won’t be a surprising move. The growth is, and should be, the biggest worry for the government and the RBI, for now. Inflation is largely a supply-side issue which cannot be controlled by interest rate hikes. That settles the debate: reviving the growth should be where the immediate policy focus should be.