The Monetary Policy Committee failed to read the signals correctly… again!

If only our own Reserve Bank of India (RBI) had taken a leaf out of the Fed’s book! Instead, what we saw was a singular reluctance to adapt, and, dare I say it, a lack of humility. The Governor’s statement at the conclusion of the three-day meeting of his Monetary Policy Committee on 8 December 2021 is more than just that – an unchanged policy rate and an unchanged (accommodative) stance.

For the ninth time in a row! No matter what, since May 2020, when the repo rate was cut to 4% for the first time, there has been a steady improvement in growth (the latest GDP numbers released by the Office of National Statistics for the second quarter of the current fiscal). Has been released, the growth rate five – quarter high 8.4%.

Meanwhile, the trend of inflation has increased. Average inflation in the last fiscal was 6.2%, which was higher than the RBI’s target range of 4-6%. In the 22 months from January 2020, it was near the low end of the range on only one occasion, in January 2021, while in 12 of those 22 months it was above 6%. The latest numbers (October 2021) show wholesale price inflation at 12.54% and although retail inflation appears to be more comfortable at 4.5%, this is largely a result of the higher base effect, i.e. higher inflation in October 2020, which is expected to close later. is likely to. December this year.

Add to that rising commodity prices, especially oil prices as well as rising global inflation, and the signs are ominous. Most importantly, policy-makers around the world are realizing that the limits of easing monetary policy have been crossed and that further easing is a string stretch.

The growth-inflation trade-off is not new. It is one of the most severely disputed in modern economics. Therefore, any decision to prefer one over the other must be based on sound theoretical/empirical models and must be critically supported, supported by sound judgment. In the Indian context, this crucial element of judgment seems to be missing.

Consider: By the governor’s own admission, “the prospects for economic activity are steadily improving, including in contact-intensive services that were hit hard by the pandemic.” “Terms of revival of investment activity are also falling. Production of capital goods remained above pre-pandemic levels for the third consecutive month during September, while imports of capital goods grew in double digits for the eighth consecutive month during October.” Moreover, “the recovery of the Indian economy is gaining traction…. All components of GDP registered year-on-year growth, with exports and imports firmly surpassing their pre-Covid levels.

Still, that recovery is not yet strong enough, according to him, underscoring the “critical importance of continued policy support for a sustainable and broad-based recovery”. What is sustainable? What is broad-based? The MPC’s statement is silent on both matters. The growth is in five consecutive quarters. Being broad based, all sectors have registered growth for two consecutive quarters.

In such a scenario, should we wait for the signs of development to be “strongly established”? Especially when all available signals are firming inflation expectations (and inflation) as well?

The governor believes the same. “The continuation of high core inflation (i.e., CPI inflation excluding food and fuel) since June 2020 is an area of ​​policy concern, given input cost pressures that could be transmitted to retail inflation faster as demand strengthens.” Is.” “The price pressure is likely to persist in the immediate term,” he says.

This explains why many central banks around the world, including BRIC economies such as Brazil, Russia and South Africa (for the first time in three years and with Omicron furious), have undergone a course correction. The International Monetary Fund has joined the bandwagon with a caveat. “Emerging markets,” it says, “could potentially face challenging spillovers if tightening by advanced economies causes capital outflows and exchange rate pressures that may require further tightening.”

Ironically, even when Governor Das pledged recovery at the press conference after the release of the monetary policy statement, his deputy in charge of monetary policy Michael Patra described growth as “really weak” and “needing a lot of support”. as was described. “Really? Some economists will lay their necks on it, especially in times of such uncertainty, Patra said, adding that any attempt to tackle inflation has to make some sacrifices for growth.

The implication is clear: Faced with a choice between rising prices and growth, the RBI and MPC chose the latter, ignoring the warning signs. Ignore that continued support for growth is likely to trigger higher inflation at this point in time. No matter what, India cannot expect to be an outlier in a world where inflation is of greatest concern. And most important, forgetting that inflation is a regressive tax. Ruthless cut of everyone!

Maithili Bhusanurmath is a senior advisor to the National Council of Applied Economic Research and a former central banker.