What signal should the new Monetary Policy Committee send?
The Monetary Policy Committee should reiterate the need for low and stable long-term inflation to ensure sustainable growth
The repo rate, which is the Reserve Bank of India’s (RBI) policy rate, has come down by 1.5% percentage points since December 2014. How much has consumer price inflation come down since then? Well, actually it has gone up, as the chart shows.
You could say, of course, that the drop in December 2014 was seasonal. Well, perhaps we could compare the 3.74% inflation in August 2015 compared to the 5.05% inflation in August 2016 then. Again, as the chart shows, the repo rate has been cut by 75 basis points since August 2015, although inflation is now higher.
Perhaps one month’s inflation data does not a trend make? Let’s consider inflation during the fiscal year so far. In 2016-17, it has averaged 5.62%, compared to 4.53%. Why would you bring down the policy rate in such a scenario?
What’s more, the latest survey of household inflation expectations in June 2016 showed that the proportion of households expecting prices to increase by more than the current rate in the next three month period and also one year forward, went up to the highest since June 2015. Simply put, inflation expectations still haven’t been adequately damped down, despite the RBI’s efforts. What signal would the new MPC send, if it reduces rates against this backdrop?
It would be much better for the newly-minted Monetary Policy Committee to continue on the path of structural reform of the monetary system, ensure a decent real return for savers, stamp down on inflation expectations, not waver from the 4% inflation target for 2017-18 and ensure that earlier rate cuts are transmitted to borrowers by the banks rather than go in for quick and needless fixes like a 25 basis point cut in the repo rate.
And they should reiterate the need for low and stable long-term inflation to ensure sustainable growth.