Is RBI doing enough to check inflation?

The inflation of India, which is measured by the Consumer Price Index (CPI), is remained above the Reserve Bank of India’s (RBI) upper tolerance limit of 6% Been going on for three months. The central bank’s Monetary Policy Committee earlier this month decided to keep benchmark interest rates, “focusing on a return to housing to ensure that inflation remains close to the target as well as supporting growth going forward.” Stay inside”. Western economies like the US have started raising interest rates. Is RBI doing enough to check inflation? Ananth Narayan and Lekh discuss the question in a conversation moderated by S Chakraborty K Bharat Kumar. Part:

Is RBI behind in controlling inflation?

Lekh Chakraborty: A fundamental rethink is needed on the effectiveness of the inflation targeting framework. The important question is, are we able to keep inflation expectations in check? The sole mandate of RBI is to look after price stability. so what do we do now? Do we modify the nominal anchor from the stated 4%? Or do we play with that band plus or minus 2 percentage points? Or are we going to do away with this framework and move to a pre-inflation targeting framework? Having said that, the context here is important. Inflation is increasing. There is geopolitical uncertainty. The war in Ukraine caused supply-chain disruptions. The consignment is getting delayed. So, it’s a supply-side shock. Maneuvering with repo rate adjustments may not work to control inflation. The reverse repo rate itself is likely to be redundant, as they have introduced a new tool – the fixed deposit facility rate at 3.75% – to absorb excess liquidity. It is a smart move to work along the monetary policy corridor, but leave rates untouched.

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Anant Narayan: I have a fundamental problem with the monetary policy framework. Monetary policy is extremely complex. All the macro variables we care about – inflation, growth, jobs, external balance, financial stability – are interrelated; You can’t target one without touching the other. And each of these is influenced by a number of policy instruments, such as interest rates (long-term, short-term, and everything in between), banking liquidity, fiscal balance, exchange rates, macroprudential rules, RBI intervention and of course, that sweetheart. The thing is called emotion. We currently have a simplified monetary framework, where we pretend that CPI inflation can be controlled almost linearly by the repo rate. Just changing the repo rate and expecting the CPI inflation to be in the range of 2% to 6% all the time… this is complete nonsense. We cannot remove economic complexity.

Now, is RBI behind the curve? There are areas where it seems the RBI was behind the curve. One, in the February policy, RBI said it expects FY23 CPI inflation to be 4.5%. It didn’t seem reliable. Now, it has revised the estimate to 5.7%. Second, for a long time the RBI insisted that the 10-year government bond yield was a public commodity to be kept low. In FY21, both the central and state governments had a record lending programme. The FY21 weighted average government lending rate was a record low of just 5.8%, as the RBI effectively sat on the curve. Therefore, the returns of savers were reduced dramatically. Our domestic inflation expectations are at 11%. Average deposit rates across all banks are just 5%. With real rates so negative, we are pushing savers to the brink, in equity markets, in bitcoin and in gold. The resulting asset price inflation is also widening inequality – the top 15% are doing very well and consuming luxury products, while the bottom 40% are struggling.

But being fair to the RBI has not been an easy time. To provide further credit, the RBI stopped its government bond purchases in October. For now, the US Federal Reserve has stopped buying bonds. Similarly, our money market rates have already risen significantly. A year ago, the one-year Treasury bill rate stood at 3.7%. Today it is 4.9%. Hence, RBI has allowed the rates to come up. I don’t think repo rate could have helped in the current context.

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Will you worry about GDP growth?

Lekh Chakraborty: Inflation expectations and the output gap are overlooked variables. How do you deal with these variables within a rule-based monetary macro framework? The output gap variable itself is controversial, as the basic assumption here is that you are experiencing cyclicity; And that once you fix the cyclicality through monetary policy, you’re going to get growth back to pre-crisis levels. This is dangerous, because if this decline in GDP is not cyclical, but has a permanent mark, then monetary policy acting as a counter-cyclical policy tool will not work. That’s why fiscal dominance is very important. Fiscal policy has been very liberal. We have a very high fiscal deficit and high debt numbers. But from a position of strength, the Finance Minister clarified that their high fiscal deficit could be evidenced through increasing investment through ‘crowding’ in private corporate investment.

Anant Narayan: The story is very difficult. Let’s agree for now that the core mandate of RBI is inflation targeting. Now there is the problem of inflation. Even for the current fiscal, FY23, if oil prices remain the same, inflation may cross 6%. It is not just oil prices, but edible oil prices, fertilisers, chemicals, feedstocks, and all-round supply chain disruptions.

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Now let’s look at the development. The real GDP for FY22 is much the same as it was two years ago before the pandemic. Effectively, two years have passed with zero actual growth. Over the past two years, inflation has been 6% compounded annually; High inflation and zero growth is a disaster. The RBI’s growth forecast of 7.2% for the current fiscal is also at risk. High oil and commodity prices underpin our growth. Exports may be affected due to the global slowdown.

This is a terrible situation with jobs as well. CMIE figures show that in the last five years, we have lost two crore jobs outside agriculture. Even before the pandemic, we were losing jobs. Our fiscal position is already stretched, our external position is going to get tougher going forward, we are looking at the current account deficit possibly towards $100 billion, this is due to the rise in oil prices in the next fiscal year. It is possible Given the global context, the fii flow looks very iffy. Even if there is FDI inflow, we are still going to see a huge outflow from RBI which has to be met. Of course, strong tax collections, thanks to formalities and record currency reserves, provide us with some buffer for now.

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This is a nightmare situation for the policy maker. What can they do to control inflation under such circumstances? Generally, when there is a lot of credit growth, it makes sense to raise repo rates and tighten liquidity. If we have 25-30% credit growth, which is creating aggregate demand and money supply, we need to stop it by increasing the cost of money. However, in the last two years, we have only made 7.5% annual credit growth, which is less than the nominal GDP growth rate. It is hard to argue that credit growth is causing inflation. In any case, we need more credit for investment and job creation.

Market sentiment is a major factor. Most central banks globally are tightening monetary policy. If we stand out and say we are not going to tighten up, it attracts negative emotion. We have to give credibility that we are focusing on inflation. Now RBI has tried to bring back credibility by focusing on inflation, which is great. Improving returns for long-term savers – not suppressing government bond yields – will go a long way in reducing inequality, controlling inflation and managing financial stability.

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The ultimate way for India to control inflation is for us to create jobs and output. The real economy is the only way to improve all of our macro variables. Monetary policy can do little for neither growth, nor jobs, or inflation control. After all, it is the real economy, where the government comes into the picture.

Is the CPI Index properly represented? How relevant is the composition now?

Lekh Chakraborty: The real issue here is the difference between WPI and CPI and, of course, energy price volatility and food inflation. So, how RBI manages to curb these is important. In India, inflation is not strictly a monetary phenomenon. There are several supply-side shocks. So, whether inflation targeting can control or drive those supply side shocks through the ‘expectation channel’ is an important question. Credit infusion – the key narrative of economic stimulus packages – is not working very well, as this credit infusion can lead to rising NPAs if there is no uniform growth in the economy.

On the fiscal policy side, the government will have to act as an employer of last resort through ‘participation income’ (not ‘basic income’) in the hands of the people by providing guaranteed employment. It may be a very strong policy by the government to tackle inflation instead of providing a huge fiscal stimulus, transferring cash into the hands of the people.

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But at the same time, where is the fiscal space? An important question is whether we can once again achieve fiscal-monetary policy coordination through deficit monetization, as Kaushik Basu and Nobel laureate Abhijit Banerjee have highlighted exactly this; They are all arguing for the re-emergence of deficit monetization through better coordination of fiscal and monetary policy. So, we need to wait and see as this is again the nature of inflation. But heretical economists always say that when you are below full employment equilibrium, it will not lead to inflation, but growth. My hunch is that it is not CPI (or core inflation or headline inflation) per se that we need to focus on from the RBI; The question is a little bigger than that, and that of ’employment’.

Anant Narayan: The way the CPI basket is built, as I understand it, is you look at the consumer spending survey, and you look at what people are consuming, and then you try to build the rural and urban basket. which is an estimate of what the average consumer actually consumes; You try to reach the median. Now the last consumer survey was conducted in 2011-12. One was done in 2017-18, the results of which remain a mystery to us. There is a report that I saw in Ideas for India. Given that there is no consumer expenditure survey, they looked at the consumption pattern indicated by CMIE’s Consumer Pyramid Household Survey (CPHS). Their conclusion was based on 2019 pre-pandemic consumer CPHS data; That the basket was not off the mark. Of course, there is a need to fix personal items like typewriters in the next consumer spending survey, which is expected in 2022-23.

But the reality is that people’s perception of inflation is much higher than the CPI numbers. This is reflected in the survey of household requirements which the RBI conducts itself. It’s not a very robust survey, so it has its limitations. But when I talk to industry people, when I talk to MSMEs too, their inflation sentiment seems to be much higher than 6%. I think the recent hike in petrol prices and diesel prices will also add to that expectation.