As Indian policymakers knock heads together over how best to stimulate our covid-hit economy, which is in need of a big financial push right now, the Reserve Bank of India (RBI) may well be in a quandary. Stimulus action, both monetary and fiscal, is necessary to prevent a disastrous drop-off in economic growth. But RBI’s efforts to pump out cash are proving less effective than desired. If that’s not bad enough, fiscal expansion by the Centre could throw its mandate of keeping a lid on inflation into jeopardy, particularly if it has to print loads of money for a government splurge. In an interview, RBI Governor Shaktikanta Das made it clear that we should have no illusions about this year’s fiscal deficit exceeding its budget figure. He also said the central bank was yet to take a view on lending money directly to the Centre, which is how deficits are usually monetized. Notably, though, he did not rule it out. If this were to happen, how big a problem would it pose?
Former Governor Urjit R. Patel, who played a major role in setting inflation-control as RBI’s chief target, seems to disapprove of any move that could let prices overshoot. In an oped on Tuesday for a daily newspaper, he argued that RBI must preserve its inflation credibility. Atypical infusions of money since last year had effectively monetized much government expenditure already, he contended; and that too, without satisfactorily easing credit conditions for other borrowers. Risk aversion among lenders was probably to blame for this, a sense of caution that has only risen after the covid crisis began. Now that tools other than RBI’s repo rate were being used, Patel expressed his concern that the central bank’s grip on inflation was also at risk of being lost. With supplies disrupted and new expenses expected, he warned against renewed inflationary expectations and asked for RBI policy to be placed firmly in the hands of its repo rate-setting panel. In all, Patel’s critique reveals more than just a little unease over RBI’s ability to contain prices should India adopt heavy pump-priming to push out cash in order to spur demand. From a long-term vantage point, this worry is easy to wrap one’s mind around. The virtues of price stability, which a fiscal overrun might threaten, have been stated often enough. For inflation to be fair to everyone, it must stay low, and predictably so. Savers, lenders and the poor have long suffered the harsh effects of an eroded rupee. If the rupee’s real value stays stable, it allows long-range calculations to be made, financial deals to be struck and foreign money to be attracted, even as credit markets operate at lower levels of risk, allowing the cost of capital to fall. All this is desirable. In general, RBI must not abandon inflation-targeting—neither in principle, nor in practice. But so long as the current crisis prevails, money supply needs to ease, not tighten. And for this, we may have to stretch our tolerance of retail inflation beyond 6% for a while, with a promise to return to the old band as soon as the economy revives.
The reality we face is stark. The current recession could last longer than a quarter. Supply chains have snapped, cash flows have turned into trickles, and corona curbs will allow only a gradual return to normalcy. Aggregate demand is crying out for a hefty boost. Small or staggered injections of cash will not suffice. This crisis calls for a big bang stimulus. And the money must not come from RBI, but elsewhere.