Opinion
RBI has wisely charted a course that’s unique to India’s economy
Summary
- Amid divergent action from major central banks around the world, the Monetary Policy Committee wisely kept rates steady. A price was paid for treating high inflation as ‘transitory’ in the aftermath of monetary policy easing during the covid pandemic and we cannot afford to repeat that mistake.
"A week is a long time in politics," said former British prime minister Harold Wilson, briefing journalists at the time of a sterling crisis. It was in the mid-1960s and Wilson was referring to the far-reaching fallout of the crisis.
Close to 60 years later, I could perhaps be pardoned for tweaking Wilson’s quote to suit the world of macroeconomics. Going by the events of the past few days, a week could have been a long time in monetary policy. Except that, to its credit, the Reserve Bank of India (RBI) chose to stay the course. Contrary to what many, especially market aficionados, were hoping.
Consider. Till just about a week ago, it was a given that RBI’s rate-setting Monetary Policy Committee (MPC) would settle for a relatively pedestrian monetary policy statement.
Sure, the six-member MPC already had two dissenters, Jayanth Varma and Ashima Goyal, both of who had argued (at the last meeting in June) for a reduction in the policy (repo) rate and a change in stance from ‘focused on withdrawal of accommodation’ to ‘neutral.’
Also read: RBI Monetary Policy: Central bank keeps real GDP growth projection unchanged at 7.2% for FY25
But the composition of the Committee—three members from RBI and three external members, combined with a casting vote given to RBI Governor Shaktikanta Das in the event of a tie—means the Governor’s word usually prevails.
And with Governor Das already on record that “it is too early to talk about an interest rate cut," given an “uncertain global economic environment and persistently high home consumer inflation," and reiterating that monetary policy has to be “clearly and unambiguously" focused on inflation, it was taken for granted that RBI would stay put.
But that was before US employment data came in last Friday showing significantly slower hiring and unemployment at its highest in nearly three years.
When markets opened the following Monday, stocks fell not only in the US, but around the world, as investors zeroed in on signs of a slowing American economy, fuelling fears that the US Fed might have waited too long to cut rates.
Talk of the US heading into recession gained currency soon after. As did talk of a new Sahm rule, wherein a 3-month moving average of unemployment of 50 basis points higher than the lowest in the previous 12 months is taken as signalling the onset of a recession. That a Fed rate cut would come sooner than anticipated was the general view.
With that, market expectations of a status quo policy from our own MPC were suddenly upended. Market expectations (hopes?), as distinct from those of economists, shifted to a change in stance, or, at the very least, more dovish commentary.
In the event, the governor showed that RBI would not be held hostage by market expectations. On the contrary, he walked his oft-repeated talk that RBI’s policy decisions are driven by domestic considerations. Sure, no central bank, least of all an emerging economy’s, can ignore the ramifications of Fed action.
But apart from a passing mention of “global financial markets exhibiting volatility," Governor Das chose to focus on domestic factors: the strength of our macro-economic fundamentals that gives RBI the necessary policy space to focus on its primary responsibility: getting headline inflation to India’s 4% target.
When pressed to comment on the conspicuous silence about last week’s market turmoil in the Monetary Policy Resolution at the press conference later in the day, Governor Das was candid. “It would be premature to talk about a recession in the US," he said, refusing to be drawn any further, other than reiterating that RBI is “watchful of all incoming data from domestic and external sources."
Also read: RBI monetary policy: Status quo on repo rate for 9th consecutive time - 5 key highlights from RBI MPC outcome
He made it clear that RBI was not going to be deflected either by the fact that core (CPI excluding food and fuel) inflation at 3.1% in May-June touched a new low. Or by the debate triggered by the recent Economic Survey’s suggestion that monetary policy should consider targeting inflation excluding food.
His caution is not misplaced. Apart from the fact that RBI’s target is ‘headline’ and not ‘core’ inflation, there has been a pick-up in retail inflation to 5.1% in June, with the likelihood of a reversal in the expected moderation in the pace of disinflation (the second-quarter projection was revised upward from 3.8% in the June MPC note to 4.4%).
Inflation is moderating, but, as Governor Das put it, the pace of disinflation is uneven and slow and there is still some distance before it aligns with the 4% target.
Second, high food inflation (food has a weight of 46% in the consumption basket) holds the possibility that it could spill over— economists call this ‘second-order effects’—to other commodities and ultimately impact core inflation.
Third, the public at large identifies with food rather than headline inflation. Fourth, high food inflation affects household inflation expectations, impacting not only the future trajectory of inflation, but also resulting in inflation getting entrenched or sticky.
The Governor was emphatic. The MPC can look through high food inflation if it is ‘transitory.’ But in an environment of persistent high food inflation, as at present, it cannot afford to do so.
Also read: Why food inflation cannot be excluded from target inflation
We paid the price (in common with other central banks, including the mighty Fed) for believing high inflation was ‘transitory’ in the aftermath of monetary policy easing during covid. We cannot afford to repeat that mistake.
