Nobel laureate Robert Lucas once observed that, ‘everyone is a Keynesian when in a foxhole’. Economies that had turned Keynesian in the wake of the virus — and are now confronted with trillions in liquidity and rising inflation worsened by war — are struggling to exit the foxhole.
On Friday, the Reserve Bank of India and Governor Shaktikanta Das attempted to fashion a policy tailored for the context. Typically, central banks and central bankers consume a few hundred words to clear the air. However, after a statement of over 3,500 words spread across an hour, the air was enveloped in a fog of expectation, notions, and assumptions.
Indians, and the investing world at large, were informed that the RBI’s Monetary Policy Committee “decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”. The statement tests the limits of the theory of Indian exceptionalism even as it presents a unique exposition in semantics — in the suggestion that a fire be fuelled and yet doused.
Even to those most sympathetic to the central bank’s predicament, the policy stance is at best a classic conceptualisation of a ‘Yes, No, Maybe’ response. Yes, the RBI expects inflation to worsen — it moved its forecast from 4.5 per cent to 5.7 per cent. No, there is no assurance that previous growth forecasts will sustain — the RBI has trimmed GDP forecast from 7.8 per cent to 7.2 per cent. Finally, the RBI says that “any projection of growth and inflation is fraught with risk” leaving the policy in ‘maybe’ territory, up for a shock and review.
There is much lather about the hawkish turn of the RBI. It is true that the yield on the ten-year bonds shifted orbits by 20 basis points to 7.13 per cent but the characterisation of the policy as hawkish would most probably send ornithologists into a tizzy. For sure the MPC and the Governor have reconstructed the sequence of priorities. “Our goals of price stability, sustained growth and financial stability are mutually reinforcing and we continue to be guided by this approach.” But there is little in the policy beyond this to arrest or at least constrain the rise of inflation.
Consider the data points from the RBI’s own statements to appreciate the collision of competing compulsions that the economy is confronted with. In his statement, the Governor quoted NSO data to underline the fact that private consumption and fixed investment, which are key drivers of domestic demand, remain subdued — only 1.2 per cent and 2.6 per cent respectively above pre-pandemic levels.
And the durability of this incipient improvement is threatened by the spectre of persistent inflation. The MPC observes “since the February meeting, the ratcheting up of geopolitical tensions, generalised hardening of global commodity prices, the likelihood of prolonged supply chain disruptions, dislocations in trade and capital flows, divergent monetary policy responses and volatility in global financial markets are imparting sizeable upside risks to the inflation trajectory and downside risks to domestic growth.’’
The threat to growth from inflation is well established. In October 1979, in a seminal talk on the management of growth and inflation, former US Federal Reserve chairman Paul Volcker said, “I don’t see this as a either or proposition. That is the basic point. If inflation gets out of hand, it is quite clear that it would be the greatest threat to the continuing growth of the economy, to the productivity of the economy, to the investment environment, and ultimately to employment.”
Inflation hurts the vulnerable the most, detains consumption, and deters investment and grounds growth. In the post-policy interaction, RBI Deputy Governor Michael Patra emphasised that for a developing economy, it is critical that the real interest rates stay in positive territory and that the pivot, repositioning of inflation as priority, is to restore the equilibrium. To appreciate the gap, one must look at the current repo rate and the trend of inflation. Bridging the gap — even assuming the forecasted average of 5.7 per cent — would necessitate half a dozen rate hikes.
The RBI has dithered to correct the imbalance, most recently in February and has wavered again. The question is what is the RBI waiting for? This column (https://bit.ly/27Savers) has pointed out that savers have been suffering negative real interest rates since long. In six of the last 12 months, consumer price inflation has hovered around 6 per cent. The likelihood of inflation nudging closer to 7 per cent is real and puts the MPC credibility in peril.
Finally, context is critical for policy. Developed economies are racing to raise interest rates, shrink balance sheets. The current consensus is that next month, and maybe again in June, the US Federal Reserve will hike rates by 50 basis points (0.50 per cent). It is estimated by the end of 2022, the US will witness seven rate hikes. Arguably, India’s level of foreign reserves and largely rupee denominated borrowings will act as a buffer. That said there is no denying that rising rates and shrinkage of balance sheets will impact flows, equity and debt, into developing economies.
Being behind the curve imposes costs and has social and political implications. Can India afford to be behind the curve?