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Central banks across the world have been issuing mea culpas, having fallen behind the curve. Closer home, it might be legitimate to ask whether the Reserve Bank of India’s (RBI) off-cycle monetary policy action of early May can also be viewed as an apologia. The question acquires both agency and urgency in light of the central bank’s monetary policy research agenda for 2022-23.

Central banks globally have acknowledged that they ignored the stubborn nature of high inflation for far too long. Fed chair Jerome Powell admitted, belatedly, that the Fed under-estimated inflation risks. US treasury secretary and former Fed chair Janet Yellen also accepted that she downplayed risks from inflation. The street now believes that the Fed, which is also underplaying last month’s inverted yield curve, might have to recant again and concede that it deliberately soft-pedalled future recessionary risks.

The yield curve represents interest rates on bonds issued by the same issuer across different maturities. The yield curve inverts when short-term rates are higher than long-term rates and this development is believed to be the harbinger of a recession. The US bond market in early April sent markets into a tizzy after 2-year treasury yields overtook 10-year paper yields. Fed economists jumped to the defence, provided a counter-point, pointing to the transient nature of the phenomenon, but the street isn’t convinced.

The Indian yield curve has not yet inverted and thus apprehensions of a future recession may still be somewhat unfounded. But yields on short-term paper—such as 91-day treasury bills—have been rising rapidly, faster than the rise in longer-dated maturities, such as the benchmark 10-year paper. In reality, the Indian yield curve is incapable of transmitting signals of future economic trends because it is still a work-in-progress, given the nature of our under-developed bond market.

The other place to look for clues used to be RBI’s annual report. The central bank’s annual report for 2021-22, its first for a reconfigured financial year (April-March, changed from July-June), was released recently. The annual report has two parts: an evaluation of the economy and an account of the central bank’s working. Unfortunately, the report seems to have become an official commendation of government performance rather than a document providing a critical review of economic developments.

Yet, clues to RBI’s thoughts on the economy lie veiled in its monetary policy research agenda for 2022-23. Two points are worth mentioning in its three-pronged agenda: preparing an economy-wide credit conditions “index" and analysing its relationship with macroeconomic variables, and, studying the investment propensity of companies or firms to better understand what constrains their hands.

Both relate to the economy’s investment climate. The investment rate, a key indicator of the Indian economy’s future, has been stagnant since the ill-advised currency demonetization of 2016. Two incontrovertible facts emerge from the country’s investment rate data over the past few years.

First, private sector investment in fresh capacity seems to have stagnated after that fateful 2016 move. The added fear of a dreaded midnight knock has not helped matters. It is well known that large swathes of the private sector are willing to make certain political economy adjustments, provided there are no sudden policy shocks. Demonetization betrayed that bargain.

Second, private investment has remained tepid despite RBI keeping benchmark interest rates at record lows for a prolonged period now. This flies in the face of continuing commentary for more than a decade that low interest rates were indispensable for a private investment revival. Conversely, the low interest rate regime has only helped the private sector’s debt repayment capacity without improving its appetite for increased investments. Even if we leave out the past two years of the pandemic, it is evident that the private sector has been sitting on the fence.

An RBI working paper of 2018 had concluded that India’s investment cycles typically lasted three years and that investment activity was affected by, among other things, real interest rates, bank credit growth and the gross fiscal deficit. Clearly, this study needs updating because not only has this been an extremely long fallow period for investment activity, but it is also now abundantly evident that record low interest rates have failed to do the trick, even after making concessions for the pandemic.

A caveat is in order. It is likely that the government’s higher capital expenditure outlays over the past 2-3 years will finally crowd in private sector investment. But, uncertain geopolitics, hardening inflation and a faltering recovery in private final consumption expenditure might still delay that recovery.

Unfortunately, RBI’s latest annual report does not provide a critical assessment of why the investment rate continues to languish; instead, it sings hosannas to the government. Come crunch time, the central bank is expected to work with the government in resolving an economic crisis, such as the pandemic-caused slump. But, at all other times, the central bank is supposed to hold up a mirror to the government, not become its cheer-leader.

Hopefully, the Reserve Bank of India’s 2022-23 monetary policy research agenda will atone for that by providing insights into unanswered questions.

Rajrishi Singhal is a policy consultant, journalist and author. His Twitter handle is @rajrishisinghal. 

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