Tapering: Is it time for RBI to take Fed-style aggressive action? – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/tapering-is-it-time-for-rbi-to-take-fed-style-aggressive-action/articleshow/85778201.cmsSynopsis

Interestingly, the Fed may have been the most vocal of all central banks in claiming that current high inflation in the US is largely transient, driven by reopening-led supply-anddemand mismatches in the labour market and temporary shortages of some raw materials. That even the Fed seems to be primed to slowly tighten monetary policy seems to suggest that central bankers cannot simply look through high inflation prints if they persist for a while.

Abheek Barua

Abheek Barua

He is responsible for the ALCO (asset-liability committee), treasury and other businesses that would require the expertise in economic research and financial analysis. He has strong academic and professional background and brings in wealth of expertise, having worked with SSKI Securities, Merrill Lynch Asian Economics Team and CRISIL.Sakshi Gupta

Sakshi Gupta

Senior economist, HDFC BankFears of an impending ‘taper’ by the US Fed — the process by which it reduces the massive infusion of liquidity ($120 billion a month) that it unleashed to fight the Covid-19 pandemic — have been triggered a fresh wave of uncertainty. Taper means less money in the global system to chase assets with. Hence the apprehension that the rallies across markets from commodities to stocks may peter out, if not reverse.

This policy of ‘normalising’ liquidity seems like a done deal. The only question seems to be whether the process starts in the last quarter of 2021 or early next year.

Interestingly, the Fed may have been the most vocal of all central banks in claiming that current high inflation in the US is largely transient, driven by reopening-led supply-anddemand mismatches in the labour market and temporary shortages of some raw materials. That even the Fed seems to be primed to slowly tighten monetary policy seems to suggest that central bankers cannot simply look through high inflation prints if they persist for a while.

So, does RBI need to fall in line, given that inflation has been hovering for a good 14 months (barring December 2020-April 2021) close to 6%, the upper end of its mandated ‘tolerance band’ for consumer price inflation?

Alternatively, do the baby steps towards reducing liquidity — the enhancement of 14-day reverse repo auction (that effectively impound free cash with banks) amounts from `2 lakh crore to `4 lakh crore and its tolerance for higher government bond yields in auctions (remember, RBI is a banker to GoI) — portend more aggressive measures?

Based on analyses of inflation data alone, the case for withdrawing liquidity support seems stronger in India than in the US and other developing economies. In the US, new and used cars, housing, hotels, airlines and restaurants constitute the bulk of inflation, with roughly 33% coming from auto prices. But, in India, inflation is more broad-based, with monthly spend on items ranging from pulses and oilseeds to fuel to health and education all trending up.

Multiple food and fuel items have been responsible for 50% of the inflation. The other half has come from higher prices for a myriad of services. If the number of product and service categories affected are indeed a gauge of ‘transience’, then inflation seems less temporary in India when compared to the US.

The Sagging Money Plant
However, it would be remiss to look at some India-specific factors before calling out for monetary policy tightening at this stage. While economic activity has picked up after the second wave, recovery continues to remain uneven, especially for the large informal sector where growth has been tepid. The increase in demand for work under MGNREGA, a safety net in the absence of other jobs, is a reminder of the accumulating stress in the rural labour market.

Moreover, wage growth has remained anaemic (in fact, dropping in some sectors), unlike in the West, where wages are rising at the fastest pace in more than a decade. Non-agriculture wage growth dropped to 0.2% year-on-year in June, compared to the US where average earnings rose by 3.6%.

On top of weak employment conditions and low wages, households have been hit by a sharp rise in medical expenses, weighing on consumer spending. The compression in a household’s capacity to spend on ‘non-essentials’ (excluding items like food, housing, health, education) is evident, going by an HDFC Bank study of the impact of Covid on expenses affected by the disease. Out of Rs 100 spent by a household, medical expenses shot up from `27 before Covid to `85 post-Covid for 10 days of treatment in a private hospital, leaving only about 15% of their total incomes available for other spending.

In contrast, in the US, consumer spending has risen substantially in recent months, with spending even higher than 2019 levels for a number of items. The strength of the US consumer story has been supported to a large extent by the direct fiscal aid provided during the pandemic. Last year, 2/3rd of unemployed US workers received more from unemployment benefits per week compared to what they were earning previously — a trend that has actually deterred people from going back to work even as job openings rise. This sort of USstyle fiscal stimulus has been absent in India, adding to the need for monetary policy to do the heavy-lifting.

Dispense With Expense? No
The looming risks of a possible third wave and virus mutations further necessitate that RBI keep its purse strings loose for now. The inflation situation could remain manageable for the next couple of months with the recent softness in commodity prices, especially oil. Also, to address high pump prices of diesel and petrol that attract a 200%-plus effective duty, isn’t inflation mitigation contingent on bringing taxes down, instead of using the sledgehammer of monetary policy?

Of course, this is not to say we turn a blind eye towards inflation. RBI could consider measures to contain — even if it is through gentle management of inflation expectations through calibrated reduction of liquidity, or loosening its grip slightly on bond yields. But with growth still on crutches, it may not be time yet for aggressive action, even if the Fed and other G7 central banks rev up their engines to tighten monetary policy.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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