US Fed and European Central Bank must not blind RBI at its August monetary policy meet – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/different-strokes-please/articleshow/84954658.cmsSynopsis

Could MPC be taking comfort from the fact that its belief that inflation is ‘transitory’ puts it in the august company of the US Federal Reserve, the European Central Bank, Bank of England, Bank of Japan, etc? That’s so much more glamorous than being in the company of the central banks of Mexico, Armenia, Brazil, Turkey et al.

It’s almost a given that RBI’s Monetary Policy Committee (MPC) will opt for status quo when it meets this week. Shaktikanta Das has repeatedly voiced his preference for growth, despite inflation hovering above RBI’s legally prescribed inflation band of 2-6%. As has his right-hand man in charge of monetary policy and MPC member, Deputy Governor Michael Patra.

A July article anchored by Patra in the monthly RBI Bulletin argues, ‘The pick-up in inflation is driven largely by adverse supply shocks due to disruptions caused by the pandemic, including increases in margins and taxes.’ Patra’s case for looking through inflation, which finds an echo in MPC’s June statement, is exceedingly puzzling, considering last year’s average inflation of 6.2%, and two consecutive inflation readings of 6.3% in May and June 2021. Despite the base effect (high numbers in May and June 2020 that should ordinarily have lowered readings this year).

Inflated Comfort Level
What explains MPC’s conviction that high inflation is transitory, a temporary price to be paid (by the poor, who can least afford it) to get the economy’s growthenginesNSE 2.77 % churning? Never mind hard-to-ignore evidence that the strategy of ‘growth first, inflation second’ has backfired — growth is in a limbo, while inflation is up. Even as many emerging market central banks have reversed their easy money policies in the face of rising inflation.

Could MPC be taking comfort from the fact that its belief that inflation is ‘transitory’ puts it in the august company of the US Federal Reserve, the European Central Bank, Bank of England, Bank of Japan, etc? That’s so much more glamorous than being in the company of the central banks of Mexico, Armenia, Brazil, Turkey et al.

According to Reuters, at the peak of the cycle in March 2020, 27 of 37 developing economy central banks cut interest rates to protect their economies from the fallout from the Covid-19 pandemic and subsequent lockdowns. In 2021, in contrast, there have already been 10 rate hikes across the group so far. India is a notable exception.

So, is MPC comparing apples to oranges? Does India really have more in common with advanced countries than with other emerging markets? Sure, there is slack in the economy. Sure, price pressures are more because of cost pressures (rise in input costs) and supply disruptions.

But the similarities with advanced economies end there. In truth, our positions could not be more different. Not just in terms of per-capita incomes, percentage of population below the poverty line and availability of social safety nets. We are at two ends of the spectrum when it comes to inflation. Inflation is a relatively recent phenomenon in the West, so one could argue it is transient. We cannot possibly say that about India.

The jump in US inflation to 5.4% in June comes after years of undershooting the Fed’s 2% target. Likewise with the EU. Despite its easy money policy, ECB expects inflation in the euro zone to hit just 1.9% this year. In contrast, we’ve had a long period of high inflation. Inflation has been above 6% in all but six of the last 20 months, with wholesale price index (WPI) inflation touching a 30-year high of 12.94% in May 2021.

Friendly Game of Tennis
Not surprisingly, inflationary expectations have risen steadily. The results of RBI’s latest Inflation Expectations Survey of Households (May 2021 round) show mean household inflation expectations one year ahead have gone up from 9.7% in May 2020 to 10.7% in May 2021, while for three months ahead, the increase is from 10.6% to 11.4% over the same period.

That is not all. The monetary policy framework has been revised for both Fed and ECB, effectively increasingly their inflation tolerance level. In contrast, recognising the Indian public’s lower tolerance for inflation and higher social cost of inflation, GoI retained the target band at 2-6% in the framework revised in March 2021.

Unfortunately, thanks to its sins of omission and commission, MPC is in a bind today. Having failed to prepare markets for any tempering of its excessively loose monetary policy, it cannot abruptly raise interest rates now, not without causing enormous damage to financial markets. But given the long and indeterminate lags in monetary policy, what it can — and must — do is set the ball rolling on a rollback by sounding just a little less cocksure, and a wee bit humble in the commentary accompanying its policy statement.

The simple ruse of a split, rather than unanimous, decision could help enormously. Unfortunately, the Indian psyche sets great store on decision-making by consensus. This, perhaps, explains the incomprehensible unanimity of views in successive MPCs meetings, with differences, if any, getting swept under the carpet.

To echo the words of Robert Kaplan, president, Federal Reserve Bank of Dallas, and member of MPC’s counterpart US Federal Open Market Committee (FOMC), ‘In a situation this complex and this dynamic, if we weren’t seeing debate and disagreement and there was unanimity, it would make me nervous.’ Likewise, MPC’s unanimous decisions are making me — and increasingly markets, too — nervous. Can we have some different strokes, please?

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