Policymakers are supposed to be know-it-alls.
How long inflation will continue blowing hot and cold, will growth sink or swim, and will the unemployment rate soar or slump?
Do they have the answers? Right now, as the RBI's economists suggested in a recent article, "we are in an age of perfect uncertainty -- everything we know is well known to all. Everything we do not know is anybody's guess."
Put another way, policymakers seem to have a little edge over any of us.
Thanks to unforeseen events, incoming data is trumping all expectations and estimates.
Inflation was easing they said. It did, only to spike after a two-month break. Likewise, markets were sure rate hikes will end in February, but RBI indicated no such thing. In a shocker, it argued the case for further tightening. Just until a few weeks ago, the global economy was on the cusp of a recession. Thankfully, that's no longer the baseline scenario, but then, nothing can be ruled out as a distant possibility.
In short, 2023, like the year before, is likely to be a period of unpredictability. And that's a problem of untold proportions, leading to policy errors.
Take interest rates. Early this month, the RBI's Monetary Policy Committee (MPC) pressed for further rate hikes citing stickiness in core inflation. But disagreements have already begun and from none other than the MPC members themselves.
Two external members including Jayant Varma and Ashima Goyal believe it's a fork in the road moment and policy stance should have such flexibility to move in either direction. In other words, a neutral stance that allows for either a rate hike or a rate cut. If the sharp rise in inflation reading in January since the last policy announcement persists, and if it raises the central bank's inflation forecast, then rates may have to be hiked further, Goyal cautioned. "That's why policy needs to be data-based from here on," she told Reuters recently.
The RBI need not keep raising rates until prices fall as it risks overshooting the inflation-adjusted real rate, which at around 1% now is appropriate for the economy, Ashima Goyal reportedly said.
"You don't need to keep on raising nominal rates as long as inflation does not come down because then you will definitely overshoot in terms of real rates," she was quoted as saying by Reuters.
A 2022 RBI study pegged the neutral real rate, the rate at which the economy is growing close to potential and inflation is close to the target, at 0.9%. And that's exactly where the inflation-adjusted real rate is currently at.
So Varma insists that risks to India's growth are higher than the risk of further inflation, justifying a pause in rate hikes. Those rate hikes would work their way through the economy and choke demand, he told Reuters, "I sometimes describe it as monetary policy driven by a guilt complex -- that we goofed up a year ago, so we should not make the same mistake, but it's okay to make the opposite mistake."
But such mistakes can be costly. Take the US Fed. In 1980, its chief Paul Volcker began rate cuts when the unemployment rate rose even though inflation peaked at 14.7%. That rate cut eroded his credibility and inflation expectations stayed stubbornly high throughout the year. To correct the mistake and regain credibility, he raised rates soon after the recession ended in July 1980, but the crushing 20% hikes landed the US in another recession in 1981 -- the most-severe recession seen after the second world war.
Ironically, most central banks seem, to what Varma calls, the guilt complex. Inflation seems to be cooling down as we speak, but central banks remain on guard fearing that markets' irrational exuberance may bid up prices and re-fuel doused inflationary fires. And remembering the Fed's policy errors, central banks would rather err on the side of caution and do more rather than less. But that could affect growth, which as it is, seems distracted enough.
Considerable uncertainty continues to prevail as incoming data are parsed. Notably, a global recession seems out of the picture, but slowdown fears persist. RBI's economists, however, believe India will 'decouple from macroeconomic projections of current vintage and also from the rest of the world.'
The key, according to them, lies in the recent union budget, which they admirably called the seventh horse of the sun. It's said in Indian mythology, that even if the other six horses of the sun's chariot are injured or exhausted, the seventh horse alone will lead the chariot to its destination.
They argued that the budget proposals led by tax revisions, CapEx (Capital Expenditure) spending, and fiscal consolidation will likely do just the same for the Indian economy.
First, the saving on taxes will boost spending by households on consumption. With India's marginal propensity to consume estimated at 0.54, the tax multiplier works out to be 1.16. Hence, India's real GDP growth would get a boost of 15 bps in 2023-24 from tax reductions alone. The budget's tax, CapEx and fiscal consolidation proposals can take India's real GDP growth close to 7% in FY24 if effectively implemented, they concluded.