The record shows that ‘Arjuna’s eye’ hasn’t quite been on inflation
Casting itself in the role of the skilled archer of the Mahabharata, the Reserve Bank of India has said it has “Arjuna’s eye” on inflation.
Casting itself in the role of the skilled archer of the Mahabharata, the Reserve Bank of India (RBI) has said it has “Arjuna’s eye” on inflation. Arjuna wins his wife, and the battle of Kurukshetra later, by keeping his focus unwavering—on the target and his dharma. The target isn’t in plain sight. The eye of a spinning fish of wood is to be pierced, seeing its reflection in water.
No, Arjuna’s eye has not been on inflation. Retail inflation was higher than 6% in each month since January this year. It has remained higher than 4% for most of the last three years now. The mandate the government set for RBI requires it to keep inflation at 4%. In case of supply disruptions, inflation of up to 6% is tolerated. Anything more constitutes failure.
RBI as Arjuna has placed the blame for failing this mandate on global supply disruptions and Vladimir Putin. But inflationary pressures were building up long before Russian forces moved.
The average inflation rate was 6.2% in fiscal year 2020-21; it continued to rule high for much of 2021-22. It was higher than 6% in each month from April to November in 2020. Arjuna had placed the blame on data inadequacies then.
True, the covid pandemic wreaked havoc. It struck in March 2020. Where was inflation before that? At 7.4% in December 2019 and 7.6% in January 2020. What was Arjuna’s eye on? On an ideological bias for cheap credit in a significant political constituency of the national leadership.
After the pandemic hit, seeing that India’s recovery was fragile, RBI concluded that inflation was the lesser evil compared to the collapse in growth: India’s GDP contraction was the worst in the world after Peru’s. While this approach may have been fine initially to cushion the economy against the debilitating impact of the pandemic, RBI kept up with it for too long. Its costly misfires include keeping the financial system flooded with liquidity long past it 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 RBI complacently shrugged off the threat to price stability and has looked less and less competent on this count.
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 the government, of course—in times of heightened uncertainty.
The central bank can say it tolerated high inflation to chase its growth mandate, but all it managed to do was lower the cost of borrowing for government—that too at a time when the government’s borrowings rose to record levels. To deliver this remarkable feat, RBI appears to have accepted higher inflation.
What made high inflation stubborn wasn’t Russia’s war, suddenly, but RBI’s policy choices. It fed the inflation dragon by actively letting monetary policy stray away from the inflation target mandated by Indian law.
For as long as inflation was higher than the target level of 4% but under 6%, RBI was comfortable ignoring inflation, as the record shows. Its monetary policy committee (MPC) started raising interest rates in May this year, only after inflation crossed the upper tolerance limit of 6%, knowing well that monetary policy shows results with lags. Until the upper limit was breached, RBI was content to limit itself to liquidity operations. It has delivered neither a revival in private investments, essential for quality GDP growth, nor low inflation.
RBI as Arjuna now says the battle against inflation is not over. Correct. What stage we are at in this battle hasn’t been said. That depends on how victory is defined. It’s unclear, however, what the exact goalpost is: 6% or 4%?
Open articulation of the target and the inflation glide path will give an idea of how high RBI’s MPC can take interest rates and at what pace—like the one RBI had announced in 2013-14 for reducing inflation to 4% and taking the economy out of the ‘Fragile Five’ crisis.
The finance ministry announced its glide path for reducing the post-pandemic flare-up in the fiscal deficit two years ago, committing to take this deficit to 4.5% of GDP in 2025-26 from the 2020-21 level of 9.3%. The finance minister is sticking with that glide path, even after the Cabinet overruled the treasury’s case for winding down the pandemic-time spending surges on foodgrains. The Centre’s fiscal deficit was 6.7% of GDP in 2021-22.
If the ministry has a glide path, what’s Arjuna’s excuse?
RBI’s staying off the 4% target over such a long period of time, the shifting of this goalpost, has gone unchallenged in New Delhi. Partly because there hasn’t been any political cost of high inflation, but also because the treasury is worried about the cost of government debt.
While the finance minister has been fiscally austere, with one eye at all times on inflation, preserving macroeconomic stability demands more. The fiscal rectitude report by the N.K. Singh-led committee has lost relevance in the post-covid world. A new fiscal anchor and timelines for reducing public debt levels need to be agreed upon.
Puja Mehra is consulting editor, Mint, and the author of 'The Lost Decade (2008-18): How India’s Growth Story Devolved into Growth without a Story’
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First Published:12 Dec 2022, 10:13 AM IST
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