Opinion
Monetary policy: RBI's optimism is tinged with chronic concerns
Summary
- India’s economy may be in a sweet spot, but consumption and private investment are still taking painfully long to pick up, even as RBI faces continuing uncertainty on food inflation.
There are many ways in which designing a monetary policy differs from drafting a Union budget. The budget is an account of money received and spent, overlaid with plans for how to structure expenditure over the next 12 months—depending on a combination of pressing political exigencies and economic imperatives—and proposals for raising money to meet this spending.
At the end of the year, it does not matter if the end- result deviates from the original, as testified by fluctuating budget deficits over the years. But, for monetary policy, the central bank’s think-tank has to use past data to hack a path to the near future, hoping to maintain a comfortable equilibrium between inflation, growth and financial stability.
The monetary policy unveiled on 7 June, in which the Reserve Bank of India’s (RBI) monetary policy committee decided to hold the benchmark interest rate at 6.5% and persist with its stance of withdrawing accommodation, was based on April inflation data.
Also read: Wall Street week ahead: All eyes on Federal Reserve monetary policy decisions, inflation data
Even though the narrative emanating from Mint Street emphasized that India’s economy is in a sweet spot, growth having revived post pandemic and retail inflation somewhat under control, some wrinkles are visible in the central bank’s policy statement.
The first sign of anxiety, though minor, is RBI’s apparent compulsion to keep an eye on policy actions by central banks in advanced countries. While the US Federal Reserve usually serves as the fulcrum for globally coordinated central bank action, the European Central Bank decoupled on 6 June and cut interest rates ahead of most other major central banks.
This has put RBI in a piquant position, even though it is at pains to emphasize its policy independence. If it cuts rates prematurely, it could lead to some retrenchment of foreign exchange reserves; if it leaves them untouched for too long, it may have to manage capital inflows and the resultant inflationary pressure.
This extraneous dependence comes on top of India’s flexible inflation-targeting regime in which factors that push up price levels (government expenditure, for example) have no accountability, but RBI has to submit a report to the Centre if its tools (higher policy rates or tighter liquidity) fail to control inflation.
The 7 June policy statement may seem mundane to most untrained eyes. But drilling a bit deeper and reading between the lines, two-three creases underline the cheer and hope that the document tries to convey. The first is slowing private consumption, which has grown by only around 4% during 2023-24, a clear sign of compressed incomes and economic stress.
Also read: Food inflation bites Indian economy: RBI sees uptick in vegetable prices; monsoon key determinant of relief
The second source of unease lies in the private sector’s tepid response to the government’s front-loading of investment expenditure. And though the RBI governor did state that capacity utilization has exceeded its long-term average, circumspection underscores RBI’s expectation of an investment revival.
But the biggest worry is reserved for food inflation, which averaged around 7% during 2023-24 and touched 7.9% in April, even though there was noticeable price moderation in other categories (including fuel). What could inject further uncertainty to the trajectory of food inflation are extreme weather events traceable to climate change.
Worse, it could spill over into generalized retail inflation and raise inflation expectations. Willy-nilly, over the next few quarters, RBI will yet again have to deal with the consequences of occurrences over which it has no control.
