To pull the plug on growth at a time when the economy is just recovering would have flushed away the gains of the first eight months of RBI’s pandemic fight
Both bond and stock markets were waiting with bated breath for RBI Governor Shantikanta Das to indicate if inflation was going to be more important or growth on the morning on December 4. While nobody expected policy rates to be reversed, the market was watching every word that could indicate the central bank was turning hawkish – an experience of past pain when earlier RBI governors pulled back just when the economy needed some more continued oxygen of liquidity.
Monetary policy is charged with keeping the flow of the gas of money to the economy at a ‘just right’ reading. Too high a flame will cause irrational exuberance that results in inflation. Too low makes the economy sluggish with growth suffering. Remember, money is the gas that the economy needs to fuel working capital, project finance, retail loans and also government spending and it is the job of the central bank to get this right.
In the past eight months, the RBI has been a nimble and pro-active central bank that has opened up the taps of liquidity and repeatedly done what it takes to keep the flow of gas going at a time when the pandemic shut businesses, reduced incomes and caused an economic standstill for weeks. The result of a co-ordinated fiscal and monetary policy has seen a dramatic bounce back in economic activity that reduced the hit on the GDP from a minus 9.5 to a contraction of 7.5% in FY21. Markets have been on a tear as they had already anticipated the sharp bounce back (if RBI did not pull the plug on growth) for the first quarter of the next financial year (2021-22). The RBI putting out a 21.9% Q1 FY21-22 number on GDP growth (see this chart) while maintaining its easy liquidity stance has told the market participants that it is status quo on the policy stance till the economy recovers. Inflation is up and so is the inflation projections for the next year – but RBI would be a lone central bank in the world to harden interest rates when the patient is still on life-support.
But putting worries about inflation on the table, but saying that we will do what it takes to keep the economy going, Das has clearly indicated to the market that growth takes precedence over inflation for the moment. As Ashwani Bhatia, managing director of the State Bank of India summed up in a TV interview earlier today: “The RBI is willing to give growth a chance." But, it does not mean that India is out of the woods – there is plenty of pain ahead and unless the co-ordination between fiscal and monetary policy continues, the recovery can stall. What we see is the bounce back of pent up demand. For it to sustain, public expenditure will need to pump up. Aggregate demand will be a problem in the months ahead if the spending power does not return to consumers.
For too long, RBI governors have taken the stance that if you stay in the cave, you won’t be blamed for getting wet. This risk-averseness has cost India many times in the past. A pragmatic MPC that is not over-targeting a 4% inflation number and a governor who is looking to use this crisis to reform is indeed good news. That is why markets are celebrating Diwali even three weeks later.
Monika Halan is Consulting Editor at Mint and writes on household finance, policy and regulation.