You could call it a formulaic expression of fuzzy distraction. In a US Senate hearing in 1987, Alan Greenspan who was then the chairman of the US Federal Reserve said “If I seem unduly clear to you, you must have misunderstood what I said.” This column had last June cautioned Brace for Impact: Central Banks Flying Blind. The gap between what is presented by central banks across the world and the policy that is prescribed appears eerily Greenspanese.
On Thursday, RBI Governor Shaktikanta Das told Indians that that aggregate demand was resilient, GDP growth was upgraded to 6.5 per cent and that inflation would be at 5.2 per cent – well above the target of 4 per cent. He then announced that the Monetary Policy Committee had decided to pause on rate hikes and emphasised the “decision to pause is for this meeting only”.
It is true that the rumble strip of events haunts the trilemma of managing growth, inflation and financial stability. Managing it oftentimes resembles mastering an avatar of Whac-A-Mole designed by Kazuo Yamada. The blunt tool of interest rate hikes is playing truant– thanks to the theory of long and variable lags. Rapid rates signal intent but what matters is sustaining levels, the risks of the higher rates for longer construct.
At the end of the day policy rate prescriptions beyond the verbiage are judgement calls and a pause to assess impact is conceivable. What is mystifying though is the articulation – the assertion of conditional pause. Arguably the MPC is well-placed with facts and models to take a call. What is the logic behind “pause for this meeting only”? Is there something which the RBI awaits (the Fed action in May) or knows something which enables a view of how the economy will play out in the coming months and the year?
It is no secret that inflation has been above the target of 4 per cent – even above the tolerance level of 6 per cent – in the past year. Is 5.2 per cent okay? Is the RBI signaling, a la Michael Spence, that it is okay with a higher level of inflation? History shows that higher growth rates are enabled by low inflation – for instance, China averaged sub 3 per cent inflation for two decades to deliver high growth.
The RBI has not done well with forecasts in the past. Which raises the question of how credible is the forecast of CPI at 5.2 per cent – given the uncertainties of geopolitics and oil prices. In April 2022 the RBI came up with a curious construct “to remain accommodative while focussing on withdrawal of accommodation” and projected inflation at 5.7 per cent for the year 2022-23. It updated its forecast months later. India ended the year with inflation at 6.8 per cent.
Inflation in India, beyond liquidity and rates, is also defined by monsoon and agri-commodities prices. There is the suspense about the possible ramifications of the El Nino impact on this year’s monsoon which could influence food price inflation. Already India, the world’s largest producer of milk is importing milk products. Supply demand balance calls for policy action. This is challenged by faultlines in allocation and utilisation of funds to prevent disease among cattle and in expanding dairy networks. The Standing Committee’s report on Agriculture and Animal Husbandry presents a sad saga of apathy across state governments.
The acceleration in credit growth is a good thing but it is also a fact that deposit rates have lagged in part due to the delayed transmission of higher rates for savers. An argument has been made by folks at the RBI that real interest rates - that is the difference between inflation and current interest rates -- would be in positive territory. This is scaffolded by the forecast or belief that inflation will not rise, inflation will slide or that banks will align returns for savers.
There are many moving parts defining the future given the “unprecedented uncertainty” Governor Das pointed out. India has historically benefited from higher global growth. This week the IMF Managing Director Kristalina Georgieva observed that thanks to fragmentation global growth will dip below 3 per cent this year and will stay around 3 per cent for five years. Indeed a World Bank Report points out that forces that powered growth are fading and that “between 2022 and 2030 average global potential GDP growth is expected to decline by roughly a third from the rate that prevailed in the first decade of this century—to 2.2% a year.”
The unknowns in the two largest economies –growth in China and asset valuations in US markets– will determine the flow of capital and output. In the US the markets are in a tizzy as fear competes with hope. Rising rates impact asset values. The easy money regime advanced the cause of real estate bets and profit-less enterprises -- funded both by public and private markets. How events play out will matter. Any crack in the markets will have a significant impact on capital flows, trade and currencies.
Finally it is useful to remember that uncertainty is the base case in economies. There is no disputing comparative merit but it is how India maps the scenarios which will matter.