The Monetary Policy Committee (MPC), in its bi-monthly monetary policy review announced on 6 August 2021, has maintained its accommodative stance, along with keeping the repo at its current 4% and the reverse repo at 3.35%. In doing so, the Reserve Bank of India has prioritised growth over the objective of maintaining inflation within a reasonable tolerance band. Quoting from the Governor’s statement, “The MPC continues to be conscious of its mandate of anchoring inflation expectations as soon as the prospects for strong and sustainable growth are assured.”
This decision to continue with the accommodative stance seems to be based on two considerations. One, on the aggregate demand side, the situation continues to be weak, warranting an expansionary monetary policy. On the other hand, the aggregate supply continues to be below pre-pandemic levels, leading to inflationary conditions. While there is consensus on restoring the supply, the assumption is that such supply bottlenecks are “exogenous” and “transitory”, and hence the MPC’s decision “to look through it”.
It is then felt that “a pre-emptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions”.
While revival of growth is indeed a noble objective, yet, assessment of inflation as a transitory phenomenon, which should ebb in Q3 2021-2022, may remain a moot point. It may be noted that as part of its transition to the Flexible Inflation Targeting framework, the RBI only refers to the headline Consumer Price Index as the target rate of inflation for monetary policy purposes. This is for two reasons. One, the CPI is supposed to be the more accurate indicator of how inflation affects the common man. Second, it has also been found that people’s inflationary expectations are more responsive to changes in the CPI than any other inflation measure, including core inflation and the Wholesale Price Index (WPI). However, trends in the other inflation measures, chiefly core inflation (inflation excluding the volatile food and fuel components) and the Wholesale Price Index (WPI) inflation point to the fact that the retail inflation indicated by the CPI may be far from transitory, and needs to be taken seriously.
The CPI inflation at 5.59% in July 2021, though below the upper tolerance band of 6%, masks the very high inflation in certain key categories that are considered volatile. Within the food and beverages category, items that have shown extremely high inflation include oil and fats (32.53%), eggs (20.82%), pulses (9.04%), meat and fish (8.33%), and non-alcoholic beverages (14.44%). With oils and fats and pulses making up the consumption basket of the common man, such inflation is bound to be iniquitous in its consumption impact across income groups.
The inflation on account of fuel and light at 12.38% and that on account of transport and communication at 10.54% are also much higher than the average CPI. The steep rise in fuel prices, combined with the lack of public transport during the lockdown, has prevented lower income groups from travelling to their workplace during the pandemic, affecting their earning capabilities and incomes. Such impact cannot be passed off as merely transitory. The non-volatile item measure of core inflation too has remained high, especially in categories like health at 7.74% and clothing and footwear at 6.46%.
The transitory nature of the CPI inflation (or otherwise) may be further studied by looking at WPI inflation.
WPI inflation has been on the rise since December 2020. The June WPI inflation at 12.07% was much beyond the overall CPI inflation rate (Numbers for July 2021 weren’t available at the time of writing this piece). While the annual rate of WPI inflation in June 2021 dropped from the high of 12.94% in May 2021, yet the month-on-month increase at 0.75% was higher than in May. It is true that the CPI and WPI comprise different items, with different weightages. Thus, manufactured goods have a high weightage of 64%, while food has a mere 15.26% weightage in the WPI. The pass-through of global commodity and crude prices is also higher in the case of WPI than CPI. However, with WPI being so high, it is likely that the effect of some of the items in the WPI basket will percolate down to the CPI as well. The latter may then continue to be high.
The pandemic has necessitated a policy response of a fiscal stimulus combined with an expansionary monetary policy consisting of a mix of low repo rates and unconventional monetary easing. The history of macroeconomic policy reveals that the use of fiscal and monetary policies have negative consequences that outlive the immediate positive impact that is sought to be achieved. A case in point is the expansionary policy mix used by India in the immediate aftermath of the Global Financial Crisis, which led to the inflationary spiral after 2009, despite a ‘temporary’ increase in growth. Such inflation necessitated RBI intervention in the form of a Flexible Inflation Targeting monetary policy regime. The lag in monetary policy transmission of about 18-24 months further implies that the inflationary impact of an accommodative monetary policy stance is likely to be witnessed even two years from now.
An accommodative policy stance is no longer justified on the grounds that the current inflationary pressures being witnessed are transitory. If at all, such growth that may result may end up being temporary. India can ill-afford to fritter away the gains it achieved on taming the inflation beast. It is time that the RBI prioritises the inflationary concerns that affect the common man.
(Views are personal)
Professor, Economics and Chairperson, Family Managed Business at Bhavan’s SPJIMR(email@example.com)