Mumbai: RBI’s Monetary Policy Committee (MPC) meeting held between September 28th to 30th has decided to hike the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points for the third consecutive time. Accordingly, the Repo rate currently stands at 5.90 percent, the standing deposit facility (SDF) rate is corrected at 5.65 percent, and the marginal standing facility (MSF) rate and the bank rate are at 6.15 percent. It has been decided that the monetary policy would continue to focus on the withdrawal of the accommodation while supporting growth. The rate hike was widely expected as inflation rose to 7.00 percent in August, up from 6.71 percent in July, and it is expected to remain sticky in the coming months. Moreover, the central bank had to take various challenges into consideration, that include weakening of global economic activity, steep rate hikes by the U.S Fed and several other central banks in the developed countries, volatile capital flows, and constant pressure on the Rupee to depreciate, reserve losses and financial stability risks, fluctuations in commodity prices and persisting geopolitical turbulences.
Some negatives and positives on the domestic front
On the domestic front, while the domestic aggregate demand has expanded on a year-on-year basis and exceeded the pre-pandemic levels, the slowdown in net exports will have negative implications. Further, urban consumption is being lifted by discretionary spending ahead of the festival season, and rural demand is gradually improving. Also, Investment demand is gaining momentum, captured by rising imports and production of capital goods, steel consumption, and cement production. The aggregate supply conditions are showing positive trends as Kharif sowing has been catching up. The industry and services sectors remain expanding, as evident from the purchasing manager’s indices (PMIs) and other high-frequency indicators. However, the index of industrial production growth decelerated to 2.4 percent in July. Considering domestic and international factors, inflation and real GDP growth in 2022-23 have been projected at 6.7 percent and 7.0 percent, respectively.
India not an outlier when it comes to inflation
Concerning the future trajectory of policy rates, The State Bank of India’s latest analysis predicts a peak repo rate of 6.25% in the current cycle with an expected rate hike of 35 bps in the December MPC meeting. A crucial question at this outset is to what extent the central bank can stick to a hawkish policy to curb inflation and inflation expectations while the global economy is precariously contemplating an imminent growth slowdown. On the brighter side, IMF’s projections indicate that India’s GDP is likely to grow at 7.4 percent during FY 2022-23, which is considerably higher than most global economies, including China. Even though the growth projections provided by different agencies vary slightly, on average, the economy is expected to grow anywhere between 7 percent to 7.4 percent. Regarding price stability, India’s inflation trajectory has been hovering above the permissible inflation band set by the flexible inflation target. However, the current level of inflation does not leave India as an outlier among both developing and developed countries. In fact, in comparison with the recent price rise faced by the European Union (10.1 percent) and the United States (8.3 percent), India’s performance is quite satisfactory, thanks to various proactive steps taken by the Reserve Bank of India.
Unfair to have high expectations from MPC
However, it would be somewhat naïve to assume that the Indian economy has the luxury of being unscathed in a highly integrated global economic order. On several accounts, the gloomy picture emanating from the international front does not assure the sustenance of the long-term growth momentum of the domestic economy (though moderate). Moreover, once the steam originating from the post-Covid-19 pent-up demand diminishes, the economy might face the issue concerning aggregate demand. Also, the recent deterioration of the current account position and mounting fiscal deficit can once again unleash the twin deficit problem. Under such circumstances, can the monetary authority alone address the issue? Unfortunately, the answer is no! Despite the ongoing monetary tightening and liquidity curbing initiated at the beginning of this year, inflation refuses to be tamed. This indicates that the genesis of the price rise is primarily supply-driven. There is a limit for monetary policy -characterised by lags- to effectively deal with unusual and unprecedented situations. And most often, the government and public over-emphasise the role of monetary policy and expect the RBI to stabilise the economy miraculously, which is indeed unrealistic and unfair.
As far as the overall economic stability is concerned, the priorities must be laid out pragmatically. For instance, price stability cannot be pursued at the cost of growth, and the objective of higher growth must not be promoted by unscrupulous monetary easing. Unfortunately, the balancing act will not be easy and requires a tightrope walk between accommodative and tight policies, for which better communication and coordination between the fiscal and monetary authorities is necessary.