How RBI postponed the necessary course-correction
Representational photo: The RBI has fed the inflation dragon by consciously and actively letting monetary policy stray away from the inflation target mandated by law. | Photo Credit: PTI
How RBI postponed the necessary course-correction
Reserve Bank of India (RBI) Governor Shaktikanta Das announced in early April that the central bank will course-correct. Instead of the earlier priority of putting ‘growth before inflation’, the RBI would now sequence ‘inflation before growth’. The impression sought to be created is that the reverberations of Russia’s invasion of Ukraine rippling across the global economy upended the inflation-growth projections for India, changing the RBI’s priorities. This signalled a change in messaging, as Mr. Das had for months and months been saying that the high inflation eating away at Indians’ savings and spending power was transitory.
However, pressures on prices had started building up long before Russian forces moved, and are proving to be more persistent than the RBI bargained for. Now, the government’s latest inflation data that came days after the RBI’s statements shows a flare-up. Inflation reached a 17-month high of nearly 7% (6.95%) in the month of March, breaching the target level of 4% that the government has set for the RBI, as also the upper tolerance level of 6%. Inflation in clothing is at a 100-month high; footwear at a 111-month high; household goods and services at a 102-month high.
International prices of food, oil, metals, already high, picked up after Russia invaded Ukraine, and companies are passing on the rising costs to consumers, which is broad-basing inflation. But the average inflation rate (6.2%) was above the tolerance band of 2-6% in the fiscal year 2020-21; it continued to rule high for much of 2021-22.
What made high inflation stubborn isn’t Russia’s war suddenly but the RBI’s policy choices. The RBI has fed the inflation dragon by consciously and actively letting monetary policy stray away from the inflation target mandated by law. With the recovery fragile, the RBI saw inflation as the lesser evil compared to the collapse in growth on the impact of the pandemic. Experts have for months pointed out that while this approach may have been fine initially to cushion the economy against the debilitating impact of the pandemic, the RBI kept up with it for too long.
The costly misfires include keeping the financial system flooded with liquidity long past such intervention was necessary; pumping money into the economy for which banks had no use, the demand for loans being modest; and buying enormous quantities of government debt, leading to the printing of new money indirectly through liquidity operations. All of this was sure to fuel inflation one day, but the RBI complacently shrugged off inflation and has looked less and less competent. For monetary policy was never going to be of much help for supporting growth, given there was meagre support for the economy from fiscal policy, and no one borrows — other than government, of course — in times of heightened uncertainty.
Inflation is paying for the budget
The RBI says it tolerated high inflation to chase the growth mandate but all it has managed to do is lower the cost of borrowing for government — that too at a time when the government’s borrowings have risen to record levels. To deliver this remarkable feat, the RBI accepted higher inflation. Inflation is paying for the budget.
It is said in the RBI’s defence, that inflation in a large poor population, inflation in India is far more torturous than in those countries. Per capita income and consumption levels in India remain below pre-pandemic levels whereas in the U.S. they had risen above those levels in 2020 itself on the tremendous support for household incomes through massive emergency relief. India’s COVID-19 relief packages, in contrast, put hardly any money in the hands of the vast majority of the population. Fiscal and monetary support reached the handful of Indians who could take loans. High inflation, thus, adds to the deepening fissures in the economy created by these pro-affluent policy biases.
The data on the permanent scars left by the impact of the pandemic will come with a lag; there’s no evidence yet to assume the whole economy is uniformly recovering. Inflation usually revives economic anxieties. The affluent are less affected as they can dip into savings and borrow at low interest rates, and sometimes even negative interest rates, as is the case right now. Savers and salary earners lose out. They think they are getting paid the same, but actually they are not because money buys less than it previously could. That’s why government announces dearness allowance and has inflation-indexed payouts for its employees. For those in debt, inflation is a boon, as it has the effect of eroding debt.
The RBI staying off the 4% target over such a long period of time, despite its legal mandate, strikes at the core question of why a country like India time and again tolerates high inflation. The piercing insights of arguably the most eminent governor of the RBI are instructive here.
Economists say the fallout is inflation when there is excessive creation of money; when excess demand originates from a budget deficit or a balance of payments surplus; when supply of consumer or wage goods fall short in relation to the level of investment.
It’s politics too
But none of this fully explains what lies behind the phenomenon they describe, explained Dr. I.G. Patel, who was RBI Governor from December 1977 to September 1982. Behind each of them is one common thing: the struggle of one section of society to claim a higher share of national income than what other sections are willing to surrender without a fight. Inflation is the manifestation of this social tug of war. It is the result of the failure to settle these power struggles amicably.
And so, he wrote, because there is as much politics in inflation as economics, it needs politics as well as economics to bring inflation under control or to avoid it.
Puja Mehra, a Delhi-based journalist, is the author of ‘The Lost Decade (2008-18): How India’s Growth Story Devolved into Growth without a Story ’. She is now working on a biography of I.G. Patel