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Home >Opinion >Views >Easy money should not outweigh price stability

The Reserve Bank of India (RBI) is widely expected to leave its key repurchase rate unchanged and retain its accommodative stance when it announces the decisions of its monetary policy panel on Wednesday. But where our central bank sees economic growth and inflation going would be parsed closely, now that a second wave of covid threatens projections of a sharp recovery in output this fiscal year after the contraction of 2020-21 and retail prices in the country remain volatile, even if within its recently re-affirmed tolerance band of 2-6%. Our daily infection numbers are grim, with a new peak of over 100,000 cases recorded on Monday, and have prompted renewed curbs in various parts of the country. To the extent that our corona crisis persists, an extended phase of easy credit would be warranted to secure a revival. The services sector, hit hardest by the pandemic, is staring at another round of covid compression and job losses, even as manufacturing loses momentum. Yet, while growth needs support, policymakers must not lose sight of rising inflation risks in the medium term.

In February, retail inflation accelerated to 5.03% from 4.06% a month prior. Benign as this may look, India’s current combination of loose monetary and fiscal policies has worried bond traders that we will at some point have more cash sloshing around than supplies of goods and services to keep prices steady. Already, RBI has been sweating to prevent market yields on government debt from rising too far above 6% at the long-tenure end of our yield curve, even calling traders “vigilantes" for resisting paper that does not offer a sufficient premium to compensate for inflation risk. While price expectations can possibly be anchored by RBI’s commitment to go after inflation with its policy tools, the need to get the economy up and moving could yet take precedence, just as it did last year, which saw retail inflation overshoot RBI’s 6% upper limit for a sustained period. Higher freight costs and hardening prices of commodities, ranging from crude oil to industrial inputs, have lately begun to exert themselves on price tags. Our overall productive capacity, meanwhile, could not have expanded much under our corona constraints. Add to this the creeping likelihood of ‘imported inflation’, should a rise in US bond yields draw capital out of India, push the rupee down, and bloat our import bills. Unlike last year, central bank policies across the world may not stay in synchrony—the US is on the verge of a big fiscal gamble—and so factors like interest-rate differentials could impact cross-border flows of money and complicate policy formulation here.

In all, a fair degree of uncertainty attends how our growth-inflation dynamics will play out over this fiscal year and the next. In such circumstances, RBI should stick to the basics of its mandate. Our central bank must now aim squarely for the midpoint of its inflation tolerance band. Growth impulses in India, on a shrunken base, might well be more responsive to the containment of covid than the cost of capital for business, which is low enough right now in real terms. The repression of Indian savers through negative real rates of interest on bank deposits (and the like) may be fine in an emergency, but this is not tenable for too long. Not only is it unfair, it could push savers towards riskier options, create conditions for a liquidity trap, and eventually distort our system of financial intermediation. Easy money is good, but not at the cost of the rupee’s stability.

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