Limits to accommodation: on RBI's monetary policy

RBI’s failure to rein in inflation will hurt savers and risk derailing a consumption-led revival

Updated - October 12, 2021 12:18 am IST

Published - October 12, 2021 12:02 am IST

The RBI’s latest monetary policy statement and accompanying actions reflect the dilemma confronting monetary authorities. While the RBI’s Monetary Policy Committee voted unanimously to keep benchmark interest rates unchanged as part of its efforts to support growth as the economy recovers, one of the six members on the MPC demurred yet again and voted against continuing with an accommodative stance for ‘as long as necessary’. Prof. Jayanth Varma had at the last meeting in August flagged the risks that prolonged monetary accommodation posed to the inflation outlook by ‘stimulating asset price inflation’ even as he posited that its impact in ‘mitigating the distress in the economy’ was arguably far more marginal. The MPC’s own current inflation outlook is a mixed bag. The projection for average inflation for the full fiscal year has been cut by 40 basis points to 5.3% even as the committee stresses that with core inflation ‘persisting at an elevated level’, the Centre and States would need to further ameliorate supply side and cost pressures, including through calibrated cuts in indirect taxes on petrol and diesel so as to address the issue of ‘very high’ pump prices. In an acknowledgment of the difficulty it faces in containing price pressures even as it keeps interest rates at growth-supportive lows, the monetary panel reiterated its plea for fiscal authorities to step in and help contain inflationary pressures, especially the pass-through impact of elevated transportation costs.

Governor Shaktikanta Das tacitly conceded that the time had come to wind down the pandemic-era liquidity support as he announced the suspension of the G-SAP bond buying programme and simultaneously outlined measures to drain out surplus liquidity from the banking system. He cited the seemingly ‘strengthening’ growth impulses to justify the RBI’s decision. Here again, the MPC’s prognostication on growth is filled with uncertainties and caveats. Contact intensive services, which contribute about two-fifths to economic output and were among the worst hit by the COVID restrictions, still considerably lag their pre-pandemic levels; the manufacturing sector is still nowhere near supporting a rebound in investment demand; and, most crucially, the external environment that has so far been a major tailwind — through capital inflows and the demand for the country’s goods and services — is turning more uncertain. With growing signs that some major advanced economies are gearing for an imminent normalisation of monetary policy, the elbow room for the RBI to stay accommodative is narrowing sharply. As Prof. Varma had noted in his dissent, monetary authorities face the danger of failing to fulfil the MPC’s primary mandate of anchoring inflation expectations firmly around the 4% target. A failure that would hurt savers the most and risks derailing a consumption-led revival.

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