The Central bank needs to adopt a cautious approach as far as monitoring inflation and pushing for growth are concerned
The National Statistical Office’s estimates for the second quarter (Q2) (July-September) of 2020-21 came as a relief to all, raising hopes of the much-talked about V-shaped recovery. The Gross Domestic Product (GDP) at constant (2011-12) prices in the Q2 of 2020-21 is estimated at Rs 33.14 lakh crore, as against Rs 35.84 lakh crore in the Q2 of 2019-20, showing a contraction of 7.5 per cent as compared to 4.4 per cent growth in the Q2 of 2019-20. This contraction of 7.4 per cent as against a contraction of 23.9 per cent in Q1 is a tremendous improvement and at current prices it turns out to be only four per cent.
Reviewing the macroeconomic and financial developments of the domestic and global economy as well as the evolving outlook for the Indian economy, the Monetary Policy Committee (MPC) decided to keep the repo rate unchanged at four per cent, the Bank Rate and Marginal Standing Facility Rate (MSF) unchanged at 4.25 per cent and the reverse repo rate at three per cent.
The Consumer Price Index (CPI) inflation at 7.6 per cent in October is higher than the mandated two-six per cent inflation target. The mandate set in 2016 requires the Central bank to keep the headline inflation at the mid-point of its range at four per cent. For most of the year, retail inflation has been outside the Reserve Bank of India’s (RBIs) tolerance limit, mainly due to supply-side pressures owing to the lockdowns.
The sticky CPI inflation has prevented the RBI from announcing further rate cuts. In the absence of much direct fiscal support, the RBI did most of the heavy lifting by reducing rates by a cumulative 115 basis points this year and pumping ample liquidity into the system.
The RBI’s flexible inflation targeting will be up for review after March 2021 and some economists think that the Central bank should keep a watch on overheating rather than trying to keep inflation within a targeted range. The US Federal Reserve, too, has indicated that it would actively seek and tolerate higher inflation in America.
Reviewing the inflation target for the RBI may give it the much-needed leverage as pressure builds on it to do more to revive the economy. The RBI has rendered support through its monetary policy and used a host of unconventional monetary policy tools to support the Government’s fiscal measures. It has made efforts to ensure liquidity in sectors with multiplier effects, nudged the bond markets to respond to the signals from the RBI in the conduct of its monetary policy and debt management. One of the unconventional monetary policy tools to be adopted by the RBI was the ‘Operation Twist.’ This refers to the purchase of Government securities of longer maturities and selling of an equal amount of securities of shorter maturities under Open Market Operations (OMO). The procedure is designed to exert downward pressure on longer term interest rates by lowering long-term yields. Besides, measures to enhance liquidity support to targeted sectors, it has been taking initiatives to deepen the financial markets, conserve capital among banks and NBFCs through regulatory support, strengthen supervision through strengthening audit function, ease external trade and expand financial inclusion.
Going forward, the primary challenge for the Central bank is going to be dealing with sticky inflation while its eye is firmly set on the recovery of the economy. In the December 3 Monetary Policy, the RBI pegged CPI inflation at 6.8 per cent for Q3 of 2020-21 and to 5.8 per cent for Q4. These projections were owing to the likely persistence of food prices at elevated levels and cost-push pressures on core inflation.
Apart from some cheer coming in with the Q2 GDP figures, there is a fear about the uncertainty of the macroeconomic conditions and the fact that the current upturn may be only due to the pent-up demand, the festival season and initial easing of the supply chain.
The results of the Consumer Confidence Survey by the RBI also showed that consumer confidence remained very low in November as compared to a year ago. However, it showed marginal improvement from its all-time low recorded in the previous cycle (September).
Low consumer confidence is reflective of the people’s insecurities regarding the job scenario, employment levels, household incomes and economic recovery in the country. However, the households remain optimistic about the scenario one year ahead as reflected by the Future Expectations Index. Hence, managing inflation is critical to sustaining the growth stimulus spurred by the policy stimuli of the Government and the Central bank.
Till now, the RBI’s efforts for liquidity injection as a response to the COVID-19 pandemic and to support the Government’s fiscal responsibility, have achieved their purpose, as assessed by the it.
Liquidity influx with Foreign Portfolio Investment and Foreign Direct Investment has been high and the RBI has been sterilising them with reverse repo operations. Going forward, the Central bank needs to adopt a cautious approach as far as monitoring inflation and pushing for growth are concerned. It should be ready to do the balancing act.
(The writer is Joint Director, the National Institute of Labour Economics Research and Development, Niti Aayog. The views expressed are personal.)