The Indian central bank resisted the temptation to alter its stance and go ahead with changes in policy rates; the move was unlike many of its peers in other economies
The Reserve Bank of India’s (RBI) February Monetary Policy is a bold statement where the central bank has chosen to stay with growth instead of worrying too much about the inflationary pressures that stares in the face of most emerging and developed economies. It is also a departure from the stance that many central banks world over have taken on this burning inflation issue.
After the first wave of the coronavirus outbreak hit the world in 2020, the US and other developed economies started infusing money in their systems and flushed the same with it. The move helped them tide away difficult times and even helped markets to run with strength despite the onslaught of the pandemic. It had a trickle down impact even on the emerging economies.
As we are into the third year of the pandemic, inflation is picking up and hence the US, along with many developed and emerging economies, is putting an end to low or nearly-zero-interest-rate regimes.
The world’s largest economy, the US has already started tapering its bond buying activity and is expected to finish it by June this year. India’s central bank has also indicated that it will be taking several measures to suck access liquidity from the system to keep inflation under its comfort levels of 4+/-2 per cent.
While the US will start raising interest rates from March and could do it at least 4-5 times over the next 12 months depending upon the trajectory inflation takes, the EuropeanCentral Bank (ECB) is also mulling over the timing to do it.
In contrast, the RBI maintained a status quo on key policy rates during the February Monetary Policy announcements. It has also said that it will continue its accommodative stance for as long as necessary.
This was despite a popular expectation / opinion that it could undertake policy normalisation and also change its stance from accommodative to neutral. There was an expectation that the RBI would narrow the difference between the repo rate and reverse repo rate. Currently, the difference is 65 bps and the expectations were that the reverse repo rate would be increase by 15-20 bps in this bimonthly policy announcement.
In its wisdom, it chose to leave the repo rate unchanged at 4 per cent while the reverse repo rate at 3.35. While the RBI has been diligently working to keep inflation in check over the last 3-4 years, it has not been at the cost of growth. He resisted the temptation to change the stance and also alter policy rates in this month’s policy announcements.
RBI View on Inflation
Inflation is at its multi-decadal highs in many economies and central banks across the world have taken divergent views on monetary policy interventions.
The MPC noted that consumer price inflation edged higher since its last meeting, but largely along anticipated lines. The increase in inflation in December was entirely due to unfavourable base effects despite month-on-month decline in prices.
Low consumption remains a problem in the country and that has checked inflation from shooting up remarkably. Low consumption is not a very healthy sign for the Indian economy even if it has put a tab on retail inflation.
The RBI estimates headline inflation to peak in Q4 of 2021-22 (January-March quarter) within the tolerance band and then moderate closer to target in H2 of 2022-23. This has given room to RBI to stay with its accommodative stance.
The estimated headline inflation for the financial year 2021-22 (April-March) has been retained at 5.3 per cent, with Q4 CPI inflation projected at 5.7 per cent. The RBI’s analysis suggests that high Q4 numbers are owing to unfavourable base effects that would ease subsequently. This will be very close to the upper tolerance levels of 6 per cent.
As for the next financial year, CPI inflation is projected to come down at 4.5 per cent with Q1 inflation estimated at 4.9 per cent; Q2 at 5 per cent; Q3 at 4 per cent and Q4 at 4.2 per cent.
The estimates point to the comfort that RBI has while managing growth and inflation as at no point it is going above the upper tolerance level. This estimate prompted RBI to maintain a status quo in this policy despite changes being seen in other top economies.
There is another high point of RBI’s monetary policies. RBI has been reiterating that it has stayed away from giving shocks in its policy announcements. It has also said that the approach will be similar going forward as well. It will first change its stance from accommodative to neutral before effecting any changes in the interest rates.
Inflation has been up primarily because of the supply side issues which are now easing. However, there is always a risk of new waves forcing lockdowns and restrictions. Geo-political tensions are keeping crude oil prices on the edge. Any adverse news could further escalate the prices.Worsening of Russia-Ukraine tensions too could blow the prices up. Many analysts have already predicted crude to hit USD 100.
Output remains a challenge in India and is barely above its pre-pandemic level, the RBI had noted. Private consumption is still lagging.
“Global headwinds are accentuating. Overall, taking into consideration the outlook for inflation and growth, in particular the comfort provided by the improving inflation 3 outlook, the uncertainties related to Omicron and global spillovers, the MPC was of the view that continued policy support is warranted for a durable and broad-based recovery,” the RBI states in its policy announcements.
Crude oil remains one of the biggest challenges and will require close monitoring.
The RBI’s optimism is derived from the trajectory of CPI inflation which has largely moved in close alignment with itsprojections.
What has worked for it is the benign food price. India is also sitting in a comfortable position as far as the food grains production and stocks are concerned. The prices of vegetables have remained high but not alarming, which has been a big solace. Large buffer stocks of cereals and effective supply side measures augur well for food inflation. Core inflation remains elevated, but demand-pull pressures are still muted.
The Government has been taking steps to bring down prices of edible oil which has been a big pain point for average households while some softening in the price of pulses has also been witnessed. All this has positively impacted the trajectory of inflation as contribution of food basket to overall inflation numbers is significant.
A further push to supply side easing could calm down prices further.
A lower inflation scenario could further allow RBI to continue with the status quo on interest rates and focus on growth. How it pans out from here will be seen when the Indian central bank announces its next policy in April.