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How RBI's status quo on key policy rates is appropriate for India
February 14, 2022

Opinion: Poonam Gupta

 

With the bond yields rising all around the world, and credit rating agencies and foreign investors starting to discriminate across emerging markets, laying down a fiscal pathway will help bolster their confidence in the strength of the Indian economy and in its key policy frameworks to yield stable policies for robust economic outcomes.


Last Thursday, RBI decided to stay the course it has been following for nearly two years. This marks 21 months in a row when key policy rates have remained unchanged, the last change being made in May 2020, when the repo rate was lowered by 40 basis points (bps) to 4 percentage points, and the reverse repo rate and marginal standing rates were also lowered by 40 bps to 3.35% and 4.25%, respectively. This status quo seems appropriate for India for three reasons.


One, inflation in India, for the most part, has remained within the range admissible under the inflation-targeting framework. Consumer price index (CPI) headline inflation has averaged 5.6% since May 2020. While it is higher compared to 4.3% achieved during the preceding five-year period, the increase in inflation has been more modest than the hikes being witnessed in advanced economies. The latter hikes are due to generous stimulus packages handed out by governments, impact of the disruption of global supply chains, inflation indexation of wages and collective bargaining, and a very tight labour market. These factors do not matter as much for India.


Headline inflation is quite likely to increase in the coming months on account of higher oil prices, which have spiralled by 60% during the last one year. Since India is a net importer of oil, this is bound to adversely impact its inflation level. However, until that happens, hiking the rates merely in anticipation wouldn't be a good idea. As such, monetary policy would be a blunt tool to module CPI inflation emanating from imported oil price hike. A more appropriate tool would be the use of fiscal policy and a counterbalancing reduction in excise duty.


Two, India is still experiencing a nascent economic recovery. As per the advance estimates for 2021-22, even till the end of the current financial year, GDP will barely climb back to the level last seen in 2019-20, and consumption would still remain 3% below that level. A policy rate hike at this juncture would have been premature.


Three, while fiscal policy has been accommodative, implementing a tight monetary policy would have sent a confusing signal. There is merit in maintaining a consistent policy narrative across different policy establishments, and in adhering to predictable and steady policy frameworks. By not tinkering with policy rates, RBI has displayed confidence in its stance, a sign of the maturity of its inflation-targeting framework.


Another useful component of the monetary policy statement is the projection for GDP growth and CPI inflation for 2022-23. RBI has projected real GDP growth at 7.8% and CPI inflation at 4.5% for next year. Meanwhile, the budget has estimated nominal growth to be 11%. Inherent in this estimation, as indicated by Nirmala Sitharaman, is the assumption that the GDP deflator will grow at 3.0-3.5%, and the real GDP will grow at 7.5-8.0%, close to the estimates provided by RBI.


While the estimates for real growth rates are quite reasonable, inflation rates may overshoot them. On RBI's part, however, projecting the CPI inflation rate closer to 4% is a sensible strategy to anchor inflationary expectations. Due to the global headwinds, and accommodating monetary and fiscal policies, CPI headline inflation will likely end up at around 5% next year. Similarly, the GDP deflator (which generally tracks the CPI inflation closely), too, will likely grow by close to 4.5-5.0%.


Hence, it seems quite likely that India will achieve nominal GDP growth rate of about 12-13% next year.


Taking India's confidence to stabilise its policy frameworks forward, in the coming months, creating a fiscal pathway to achieve more sustainable outcomes would be welcome. Indeed, if growth stabilises in a post-Covid world next year, tax buoyancy picks up and the generation of non- tax revenue gathers momentum, implementing such a framework should be quite feasible.


Similar to the inflation band in the inflation-targeting framework, the proposed fiscal framework may initially be built around a range of fiscal targets, rather than around point targets. The range can then be calibrated and narrowed down, conditional on the pace at which these targets are attained and the manner in which the economic recovery unfolds.


With the bond yields rising all around the world, and credit rating agencies and foreign investors starting to discriminate across emerging markets, laying down a fiscal pathway will help bolster their confidence in the strength of the Indian economy and in its key policy frameworks to yield stable policies for robust economic outcomes.

 

The writer is Director General, NCAER. Views are personal.

 

Published in: The Economic Times, February 14, 2022