RBI obsession with inflation – refuses to go!

In its 4th bi-monthly monetary policy review for current year [announced on October 4, 2017], the Reserve Bank of India [RBI] has kept the policy rate [rate at which apex bank lends money to commercial banks] unchanged at 6.0%.

This has come as a rude shock to industries and businesses especially the small and medium enterprises [SMEs] which were anxiously looking forward to a cut for giving much needed fillip to growth. The SMEs are at the core of Prime Minister, Modi’s agenda for promoting growth, creating jobs and increasing income. Under MUDRA [Micro Units Development Refinance Agency] Yojna, the banks have so far disbursed loans worth Rs 320,000 crores to about 75 million persons. Lower interest rate could have helped self-employed persons in reducing their loan repayment installment under the scheme.

At present, India is confronted with dip in GDP growth for 5 consecutive quarters, this being more pronounced during the last two quarters namely January-March, 2017 and April-June, 2017 when growth slipped to 6.1% and 5.7% respectively. These can be attributed primarily to demonetization and GST [goods and services tax] both of which are necessary to bring about a structural transformation in the economy for benefits in the medium to long-term.

The union government is working on all fronts to minimize the short-term pains of these revolutionary steps, smoothen the transition and keep up the momentum of growth. Those steps include addressing glitches in implementation of GST, getting to recover tax/penalty on the mountain of unaccounted cash deposited in banks [post-demonetization] and use of resources thus generated to support social welfare schemes, increase in government capital spending and improving the ease of doing business for encouraging private investment.

As projects are kick-started, small businesses get a push, affordable housing schemes – in both urban and rural areas – gather pace and investment in infrastructure projects viz. highways, roads, ports, airports, rails, irrigation etc get a leg up, all these will need financing at lower interest rates. This is needed to make Indian goods and services competitive more so in international markets [to increase exports] and make available essentials like housing at low price.

The reduction in policy rate has to be viewed in this larger perspective of accelerating growth and creating jobs. But, this does not seem to figure on the priority list of the apex bank. This is despite it recognizing the downturn and even revising its estimate of growth for current year first to 7.3% – down from its earlier estimate of 7.4% – in the second bi-monthly monetary policy review [announced in June] and now further down to 6.7% in the current review.

The RBI has also cautioned the government against indulging in excessive public expenditure if only to boost growth as that would risk fiscal consolidation and prove to be inflationary. Team Modi is fully conscious of its responsibilities in this regard and acting very much within the limits of fiscal prudence. It is fully confident of sticking to fiscal deficit target of 3.2% of GDP for current year.

However, for spurring growth, it was looking forward to the RBI for extending a helping hand which the latter is unwilling to concede by maintaining the so called ‘neutral policy stance’. In February, 2017, even while avoiding rate cut, it had changed its stance from accommodative to ‘neutral’ and has since stuck to it in all subsequent four reviews [April, June, August, October]. A neutral stance does not commit apex bank to lowering the rate though, even with accommodative stance, there is no guarantee that it would reduce interest rate [as happened in December, 2016].

The sole reason for RBI’s intransigence is that it does not want inflation to go out of control. Even in this regard, the Monetary Policy Committee [MPC] which decides the rate has chosen to ignore RBI’s own dictum that it can go soft on interest rate if the consumer price index [CPI] is within target range of 4% [+/-2%] on either side. During the first half, CPI was 2.0-3.5% whereas for the second half, it is estimated to be 4.2-4.6%. So, inflation is well within the target range yet, the MPC has refrained from a cut in the policy rate.

The committee justifies its decision in terms of a number of upside risks to inflation viz. farm loan waiver, deficient rains, implementation of 7th pay commission recommendations and global risk such as increase in oil price. It is hard to fathom as to how any of the mentioned factors would trigger inflation. A loan waiver does not put more money in the hands of the farmer. All that it does is to exempt him from paying back a portion of his pending dues.

The pay commission award does put more money in the hands of employees. Here again, it is absurd to surmise that this will fuel inflation. Far from that, it will help industries hamstrung by low production [courtesy low demand] to improve their utilization rates and even go for fresh investment further propelling growth. Any impact on food prices is ruled out as demand for such items is limited by consumer’s needs/diet constraints.

As regards, oil price, it should be noted that since 2014, the impact of cartelization by OPEC [Organization of Petroleum Exporting Countries] group has been substantially dented by abundant supply of shale oil & gas from USA. Consequently, Indian basket of imported oil is much more diversified now making it less vulnerable to machinations of OPEC. On balance, oil price will remain benign.

In a nutshell, RBI is overly concerned about inflation – much of this imaginary. At this juncture, the economy faces demand compression including for capital goods. Modi – government is pulling all stops to give it a boost. The apex bank should help it instead of becoming a hurdle in the guise of a problem [read: inflation] that does not exist.

But, for now, any hope that it will change gears is dim!

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