MPC: Focusing on growth

At this point, the Reserve Bank of India’s Monetary Policy Committee is justified in holding back on monetary policy normalisation

No one expected any interest rate action from the Reserve Bank of India’s Monetary Policy Committee in its Wednesday meeting — and sure enough there wasn’t any. The repo and reverse repo rates (the interest rate at which RBI lends to banks, and the interest banks earn for parking their excess cash with the central bank) have been kept the same. The Indian economy grew 20.1% in the first quarter of 2021-22, and 8.4% in the second, but RBI, which retained its 9.5% GDP growth estimate for 2021-22, said that the recovery may not be “self-sustaining” or “durable”. And in pursuit of a “durable, strong, and inclusive” recovery, it decided to retain its accommodative stance. RBI expects inflation to be 5.3% in 2021-22 and come down to 4-4.33% by the end of 2022-23.

RBI expects inflation to be 5.3% in 2021-22 and come down to 4-4.33% by the end of 2022-23 (REUTERS)

While the lack of interest rate action was not a surprise, the dovish tone of the committee definitely was. Growth has recovered, 19 of the 22 high frequency indicators tracked by the government being at or above pre-pandemic levels, and with inflation continuing to remain high (albeit within the central bank’s comfort level), and core inflation remaining stubborn since last year by the bank’s own assessment, analysts may be forgiven for expecting a more hawkish tone from the committee. Several questions arise. Is the MPC right in its view that the current level of inflation is transient? Is its evaluation of the current recovery nor being sustainable without help accurate? And is RBI over-relying on the ability of the non-interest rate actions at its disposal (such as variable reverse repo rate auctions) to tighten the money supply? There are no clear answers to any of these yet.

But the central bank is correct when it says that private consumption and investment — both key ingredients of growth — are still below pre-pandemic levels. The first (private consumption) is key to growing aggregate demand, the lack of which was a problem ailing the economy even before the pandemic struck. It is largely government spending that has helped the economic recovery. That, and the possibility of the Omicron variant causing at least a stutter in the economic recovery — perhaps more if it turns out that the variant has the ability to evade vaccines — may have prompted it to prioritise growth over liquidity normalisation. That may well be the correct approach at this point in time.