An accommodative stance on monetary policy (unchanged since June’19), in the face of an unfavourable growth-inflation trade-off is understandable for now
Tirthankar Patnaik, chief economist, NSE.
The third bi-monthly policy review this fiscal would find the RBI’s MPC in familiar territory. While growth concerns linger on in the wake of the second wave of the pandemic and an impending third, cost-push inflation pressures and renewed supply-side bottlenecks have translated into a board-based spike in inflation prints. That leaves limited options from a policy perspective.
Since the last review meeting in June, several high-frequency indicators have broadly recovered from the second-wave slump, aided by a gradual easing of curbs imposed by states; however, consumer as well as business sentiments remain subdued amidst an uncertain economic outlook. On the inflation front, June’s CPI print of 6.3% marked the second consecutive month of inflation breaching the RBI’s upper limit and 21 consecutive months of it staying above the 4% target. In addition to the supply-side disruptions and logistics costs imposed by the pandemic, this trend broadly also reflects cost-push pressures from higher commodity prices, buoyed by the global economic recovery.
While achieving price stability by anchoring inflationary expectations is the MPC’s stated mandate, growth and economic uncertainty have taken greater precedence since the unprecedented Covid-19 pandemic hit the country and the globe. This is reflected in the Governor’s regular communique, meeting minutes and past statements.
The goal has been to revive/support growth sentiments with adequate and targeted liquidity support, while looking through yet another sharp spike–hopefully-transient–in the already-high inflation trajectory.
Focus this time too is expected to remain decisively towards alleviating growth concerns despite rising inflationary pressures. The MPC is most likely to keep rates unchanged for the seventh consecutive policy, divergent to emerging market peers like Brazil and Russia. In fact, the status quo is quite likely to continue through the financial year, and not merely to avoid a 2018-like situation.
As the latest Fed commentary also shows, the growth-inflation trade-off is a tightrope walk that necessitates flexibility. The ECB too, has revised its monetary policy setup to allow inflation to be symmetric around the 2% mark over the medium term. And in marked contrast to these regions, Indian households have dipped into their savings in facing the extended pandemic.
The nascent recovery since June, therefore, is unlikely to translate into upward revisions in the RBI’s growth projections of 9.5% for FY22, thanks to persistently high infection rates in a few states and impending risks of a third wave. At the same time, the temporary rise in consumer and then not-so-temporary rise in wholesale inflation might coerce the MPC to revise its CPI inflation forecast (FY22 average of 5.1%) yet again, possibly accompanied with upside risks.
An accommodative stance on monetary policy (unchanged since June’19), in the face of an unfavourable growth-inflation trade-off is understandable for now. It could get worse before getting better; lingering price pressures as the supply side matches up with demand revival locally and globally may keep the inflation trajectory elevated for longer than expected, leading to renewed concerns on the market pricing of risk and term premia. Markets calmed after the recent RBI commentary in mid-July, but rates have been inching up since then.
It is here that greater clarity, esp. on what the MPC sees as the medium-term trajectory of inflation, alongside a time-bound response plan, would help in meeting the core objective–that of setting the right expectations on growth and inflation for households and the markets (compressing the inflation risk premium), and the ancillary one–setting the optimal rate for market borrowings.
The author is chief economist, NSE. Views are personal