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The just concluded meet of the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) is noteworthy for reasons that go well beyond the immediate, one of them being its oblique hint of the beginning of a ‘pivot’ (reversal in policy). So, even as it reduced the pace of increase in the policy repo rate to 35 basis points (taking the repo rate to 6.25%), rather than 50 basis points, as in the three previous meetings commencing June 2022, the meet was marked by several ‘firsts’.

To start with, it was the first after the last unscheduled meet held in early November, when the MPC met to discuss the letter to the government, mandated under the RBI Act, 1934, detailing why it had failed to keep inflation within the target band of 2-6% for three consecutive quarters, the blueprint of proposed action to get inflation down to 4% and how long it would take to do that. Yet, the resolution was completely silent on this.

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Presumably, the letter has since been sent by RBI but is under wraps since, as RBI Governor Shaktikanta Das stated at the press conference following the MPC meet in September, it would be a “confidential" document. We are, therefore, no wiser regarding its contents. This is unfortunate. Logically, it would have outlined a concrete plan of action far more meaningful than a mere statement that monetary policy would remain “focused on withdrawal of liquidity." More so since RBI’s shift in stance from ‘accommodative’ to a focus on ‘withdrawal of liquidity’ found mention as far back as in the June 2022 policy. Yet, even today, the system remains in surplus. Despite much faster growth in credit than in deposits!

Indeed, the MPC’s penchant to turn a blind eye to the dissonance between liquidity and rates is puzzling, to say the least. As former RBI Governor C. Rangarajan has stated in his recent book, Forks in the Road, My Days in the RBI and Beyond, a policy where liquidity management is not in consonance with rate action will not be effective: “Central banks cannot act like King Canute. They cannot order interest rates. They must act on liquidity such that the proposed changes in the policy rate stick."

Remember, this was also the first MPC meet after the National Statistics Office published gross domestic product (GDP) data for Q2 (June-September 2022) showing a patchy recovery; overall growth came in at 6.3%, even as manufacturing (the sector most impacted by monetary policy) contracted 4.3% and mining contracted 2.8%. In this scenario, to hope that India can remain an “island of resilience in an otherwise gloomy, volatile world" seems rather optimistic. Geopolitical uncertainties, monetary tightening globally and looming recession in close to a third of the world, all risks enumerated by the governor himself, are likely to be a dampener in the days ahead, even if we do achieve 6.8% growth (reduced from 7% earlier) this fiscal.

Most importantly, this is the last MPC meet and policy statement before 1 February 2023, when finance minister Nirmala Sitharaman will present her last complete Budget before the next general elections in 2024. The next MPC meet will be held early February 2023, after the Budget. Hence, it would have been good if the statement had given a clear policy direction.

Alas, that direction is conspicuously absent. Sure, the governor has reaffirmed that his focus remains on inflation control: “the battle against inflation is not yet over." But in a scenario where “inflation has ruled at or above the upper tolerance band since January 2022, core inflation is persisting around 6%" and “headline inflation is expected to remain above or close to the upper threshold in Q3 and Q4:2022-23 and is likely to moderate in H1:2023-24 though remain well above the target," rate action and liquidity management must move in tandem.

Sure, growth is likely to be adversely impacted. Which is, perhaps, why two MPC members, Jayanth Varma and Ashima Goyal, did not opt to go along with “withdrawal of liquidity". As Jayanth Varma writes in the minutes of the last MPC meet, “It is possible that if we were to continue to tighten without a reality check, we would run the risk of overshooting the repo rate needed to achieve price stability… However, since monetary policy acts with lags, what is relevant is the inflation forecasts 3-4 quarters ahead. Both the RBI’s forecasts and the survey of professional forecasters show inflation falling to around 5 percent in the first quarter of the next financial year."

So, the MPC can overshoot and harm growth. That is a risk that all central banks, including the US Federal Reserve, run once they allow the inflation genie to escape from the bottle. But if inflation is the central bank’s enemy number one, there is no option but to tighten monetary policy and pursue it to its logical end. Regardless of its consequences for growth! It is then for the government to ease the pain for those who can’t bear it. Trying to kill two birds with one stone may be a smart proverb; but it seldom works in real life. Not when it comes to central banks charged with inflation targeting, like RBI. That’s more likely a recipe for failure—on both the inflation and growth fronts.

Mythili Bhusnurmath is a senior journalist and former central banker.

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