Three monetary policy statements in the same month. And the first quarter of the current financial year is not over yet. This type of example is an example of the frightening times we live in. But the latest statement issued by the Reserve Bank of India (RBI) on Wednesday is quite different from its previous two documents. It includes the dreaded “S” word for the first time: stagflation.
Stagflation was not originally part of theoretical economic discourse, but a portmanteau coined during the 1960s–1970s to describe a state of stagnant economic growth accompanied by rising inflation rates. The situation poses a dilemma for central banks as measures to control runaway inflation usually further slow economic growth and rising unemployment. A similar dynamic applies to India today.
While economic growth prospects are shaky, India has been witnessing a tight inflationary environment over the past few months. Producer prices, reflected in the WPI growth, have been rising in double digits for the past few months. It is now feeding in end-user prices, with the consumer price index up 7.8% in April.
Inflationary compulsions seem to have forced the RBI to further enhance its policy pivot – from boosting growth to fighting inflation – which began in April. Monetary policy for June hikes the benchmark repo rate by 50 bps, taking it to 4.9% (which is still below pre-pandemic levels). With the first rate hike of 40 bps coming at an off-cycle policy meeting held in the first week of May, it is the second hike in as many months.
The central bank has also decided to change its stance. The latest policy statement focuses on “the return of housing to ensure that inflation remains within targets while supporting growth as we move forward”. This is quite different from May’s stand of “adjustment focusing on return of housing”. Translation: The term “accommodation” is no longer supported and as per the central bank’s revised liquidity framework, the central bank will withdraw excess liquidity from the system until the weighted average call rate is close to – or exceeds the repo rate Will continue , introduced in January 2020.
The central bank has exhausted liquidity near 3 lakh crore in the last 12 months, mainly through the means of Variable Rate Reverse Repo (VRRR). there is a possibility that another 2-2.5 lakh crore will be absorbed before the central bank achieves its “neutral” rate, or interest rate that is neither accommodative nor stunts growth. The instrument of choice could be VRRR, open market operation or even an increase in the cash reserve ratio.
There is another important lens through which the current monetary policy statement can be viewed: Given the flux in global economic conditions, it may be prudent to determine the RBI’s future course of action based on near-quarter projections. For example, a 90-bps increase in benchmark rates in 30 days should probably be seen against RBI’s Q1FY23 forecasts of consumer price inflation at 7.5% and gross domestic product (GDP) growth of 16.2%. Thereafter, both inflation and GDP growth projections are reduced; But, it is a dynamic situation, and it needs to be closely monitored and investigated. The future course of the central bank will be based on the evolving situation.
It is the instability and uncertainty in the global economy that increases the fear of stagflation. The first mention of the stagnation in the global economy, including emerging markets, appeared in the RBI’s annual report for 2021-22, released about 10 days ago: “Policy trade-offs are becoming increasingly complex and tailwinds including stagflation.” The risk, , looms large in many countries.”
This foreshadowing of stagflation pressures is also echoed in the World Bank’s latest Global Economic Prospects report. In his proposal, World Bank Group President David Malpass did not draw his punches, specifically how the poorer countries are likely to be the hardest hit: “Many years of above-average inflation and below-average growth are now accompanied by potential volatility.” There are likely to be consequences for low- and middle-income economies. This is a phenomenon – stagflation – that the world has not seen since the 1970s.” The circle is completed with the latest monetary policy statement as well as the statement by RBI Governor Shaktikanta Das, raising concerns over stagflation.
In the growth-inflation dynamic, RBI’s actions are now firmly rooted in the management of inflationary expectations. This immediately puts a question mark on India’s GDP prospects, though the RBI has persisted with its GDP growth projections of 7.2% for FY13. Incidentally, a major component of the rise in prices is expected to stem from higher food prices. This will also require some efficient supply management by the government.
This leads to the emergence of a new, post-pandemic dynamic: the government versus the central bank. In the policy document, inflation is forecast to exceed the 6% upper limit in almost all quarters. The RBI Act is clear that if the inflation rate remains above the upper limit for three consecutive quarters, it will trigger some government action. RBI is required to submit a report, which outlines the reasons for the rise in inflation and gives some suggestions for remedial action. The question is, will this highlight government action as the primary cause, or will it blame the globalization of inflation? This place needs to be watched carefully.