Monetary policy: Is it time for the RBI to bite the bullet on interest rates? – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/monetary-policy-is-it-time-for-the-rbi-to-bite-the-bullet-on-interest-rates/articleshow/86850026.cmsSynopsis

The RBI has been patient and optimistic about inflation so far. But the ripples of inflationary speculation are beginning to be felt in both the financial markets and industry. The bonds and the rupee have come under pressure because of the concerns about the detrimental impact of high energy prices on India’s economic recovery and growth.

C K Ranganathan

C K Ranganathan

Founder-chairman, CavinKare, and president, All India Management AssociationWhile it is true that monetary policy cannot increase the supply of chips and ships immediately, central bankers across the world are coming under pressure to do something about the high inflation that is accompanying economic recovery. Despite declaring the inflation transitory, they have to contend with rising energy prices and possible entrenchment of inflationary expectations.

So far, most central bankers, including the Reserve Bank of India (RBI), have linked inflation exclusively to the supply shock caused by the Covid-19 pandemic. They have tried to talk down inflationary expectations by maintaining that inflation will return to pre-Covid levels once production recovers. However, the mood is beginning to turn grim. Some economists have even raised alarm about potential stagflation.

While there is no ready model available for firing up growth and cooling prices simultaneously during a supply crunch, the RBI is still expected to make it happen. The biggest point of interest in today’s expected RBI policy statement is the interest rate. Clearly, nobody wants the interest rate going up because it would disrupt growth without suppressing prices. Moreover, it could make the worst fears of stagflation come true by discouraging increase in supply through higher production and investment.

However, it will be difficult for the RBI to maintain the status quo as inflation worries grow. It must be seen doing something about it.

Globally, the debate about inflation is beginning to turn contentious. The spike in fuel prices has changed the mood. The earlier treatment of inflation as logical reflation during an economic recovery is giving way to arguments over inflationary expectations settling in. Central banks are reluctant to hurt the recovery, and want to hang on to easy money policies as long and as much as they can. In any case, most of them do not see a role for the monetary policy in solving the supply-side problems instantly.

The RBI has been patient and optimistic about inflation so far. But the ripples of inflationary speculation are beginning to be felt in both the financial markets and industry. The bonds and the rupee have come under pressure because of the concerns about the detrimental impact of high energy prices on India’s economic recovery and growth.

The high taxation of fuel has already been a key factor in keeping the inflation at the higher end of the RBI’s inflation target band. Now, worries about rising crude and gas prices, and shortage of domestic coal, are spooking industry. India has cut down on its import of coal, which produces 70% of the country’s electricity, because of rising prices, and the recent rains have affected output of local coal.

Coal stocks with the power plants are running low. Unless the local coal production ramps up quickly, India will have to import high-cost coal, which will have a cascading effect on inflation.

India has to keep an eye on the global inflation and monetary policy trends and nimbly adjust its growth recovery measures. China, where prices had already been rising for the past many months, now has to enforce power cuts in the industrial cities, which is further exacerbating supply of critical items in the world and driving up inflation. The EU has seen its highest inflation level since the global financial crisis 13 years ago.

The US is beginning to feel a drop in its growth momentum as fuel prices and wages are rising. Even Germany, which avoided the global stagflation of the 1970s, is witnessing more than 4% inflation after nearly three decades and its industrial unions are demanding wage hikes and even striking work.

Central bankers in rich economies have indicated their willingness to review their interest rate and liquidity stance if inflation begins to affect economic recovery. The actions of the US Federal Reserve are of particular interest to India, as any reversal of easy money policy in the US is likely to affect capital flows to India and destabilise the rupee, which, in turn, would impact India’s cost of imports and export competitiveness.

In many significant economies, such as Russia, Brazil and New Zealand, the central bankers have already reacted to inflation and raised interest rates. The consequences of these hikes are still not fully known. RBI and other central banks are in uncharted territory, and they need to show their monetary policy chops to rescue the growth recovery from the spectre of inflation.

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