In the second bi-monthly monetary policy review for the current year announced on June 7, 2017, the Reserve Bank of India [RBI] has kept the policy rate [rate at which apex bank lends money to commercial banks] unchanged at 6.25%.
This has caused consternation among stakeholders including from the government. The chief economic adviser [CEA], Dr Arvind Subramanian has gone that far to lambast the apex bank for erring in projecting inflation disproportionately on the higher side. The inflation rate as measured by consumer price index [CPI] is used by RBI as benchmark for deciding the policy rate.
The prime reason for the disappointment is that the Monetary Policy Committee [MPC] which decides the rate has refused to factor in the slump in GDP growth rate [it declined to 6.1% during last quarter of 2016-17 and is projected to be 7.3% – down from earlier estimate of 7.4% by none other than RBI itself] as also the fact that private investment continues to languish.
The interest rate is considered to be a potent instrument of giving a boost to investment. A reduction in the lending rate [it is positively co-related to policy rate] lowers the cost of project finance and working capital which in turn, gives a fillip to business activity across all segments viz. big corporate, small and medium enterprises. Since, this has not come about, the discomfiture was inevitable.
An indication of committee’s unwillingness to go for a rate cut was available from the review announced in February, 2017. Then, even while avoiding rate cut, it had changed its stance from accommodative to ‘neutral’ and continued in April, 2017. A neutral stance does not commit bank to reduction though even with accommodative stance, there is no guarantee that it would reduce interest rate [as happened in December, 2016].
That the MPC had a pre-meditated and unrelenting mindset would be clear from the outright refusal by all of its members not to meet officials of finance ministry who had scheduled a meeting with them prior to the policy review. Had they been open to reasoning and willing to argue out their stance, they would not have said an emphatic ‘no’ to holding an interactive with the officials.
On the other hand, it would be naive to view a meeting as tantamount to infringement on the autonomy of RBI – as argued in some quarters. If, the government were to interfere, it could have done it anyway. Those who interfere and exercise control do it in a subtle manner [as happened under UPA – dispensation]; they do not go for meeting which is a fairly open and transparent process.
The committee also chose to ignore RBI’s own dictum that it can go soft on interest rate if CPI is within target range of 4% [+/-2%] on either side. For 2017-18, it has projected inflation to be 2%-3.5% during first half and 3.5%-4.5% during second half. These numbers are well within target range; yet, MPC refrained from a cut in policy rate.
Clearly, the imperative of giving a boost to sagging private investment did not move committee members. That growth of bank credit during 2016-17 has been lowest in 15 years and there was dire need to lift it failed to turn them on. Even its inflation projection being within target range has not rattled them. So, what has held them back?
The policy statement refers to several upside risks to inflation particularly during second half which might force them to retreat and that would affect credibility of the policy. The argument draws too much on imagination to a point of absurdity. Even if inflation shoots up say within two months, there is nothing wrong in taking a re-look. After all, policy review is done every alternate month.
So, what are the risks? The committee has listed farm loan waiver, implementation of 7th pay commission recommendations and global political and financial risk. 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 farmers. All that it does is to extinguish a pending liability that he was unable to clear [owing to difficult economic circumstances facing him].
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 be a great help to industries suffering from low capacity utilization 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 diet constraints [no consumer buys more than what he needs].
At another level, RBI’s overemphasis on inflation management [via reining in money supply] on one hand and bumper supplies [courtesy, government push to increase in area under cultivation and higher yield] is leading to farmers distress due to resultant dip in prices. The impact is felt especially on farmers growing horticulture crops and pulses [current crisis in Madhya Pradesh and Maharashtra].
As regards, global risks, committee’s main concern is due to a spike in price of oil wherein we import 80% of our need. This is based on the decision of OPEC [Organization of Petroleum Exporting Countries] as also non-OPEC countries led by Russia to extend the cut in oil supplies [agreed to late last year effective from January 1, 2017] by a further 6 months. But, it does not take in to account the abundant supply of shale oil & gas from USA and now the unloading of huge stocks by Nigeria and Libya. On balance, oil price will remain benign.
In defense of its stance, MPC has also contended that there was inefficient transmission of rates in the past [ref to banks not passing in full the rate cut – a cumulative of 1.75% since January, 2015 – to the borrowers] does not cut ice either. RBI needs to do what lies within its remit.
In a nutshell, RBI is overly concerned about inflation – much of this imaginary. On the other hand, its decision not to lower the policy rate is bound to take ‘certain’ toll on investment and growth. It needs to shift gear before it is too late.