Updated: December 7, 2020 8:24:48 am
The Governor of the Reserve Bank of India, Shaktikanta Das, at the RBI office in New Delhi (Express Photo / Tashi Tobgyal / Archive)
Dear readers,
Exactly one year ago, Finance Minister Nirmala Sitharaman was asked if India faced stagflation, which refers to a phase in which an economy experiences stagnant growth and persistent high inflation.
The question was asked because India’s growth rate in the first two quarters of the last financial year (2019-20) had decelerated sharply to a six-year low and retail inflation, or the rate of increase in prices that we face As consumers, it had skyrocketed in November 2019.
She had reportedly responded: “I have heard of the narrative and have no comment to make.” To be fair, at the time, the calls for stagflation were quite premature.
For one thing, retail inflation had risen for just a couple of months. In addition, the main culprits were food prices, especially fruit and vegetables, which had skyrocketed after off-season rains reduced supplies.
It was expected that, before long, the “transitory” peak in inflation would subside and GDP growth would regain momentum.
But it didn’t happen either.
GDP growth continued to falter: it continued to slow in the third and fourth quarters before Covid forced it to contract by 24% and 7.5%, respectively, in the first two quarters of the current financial year (2020-21). .
The inflation rate remained persistently high until the Covid outage made it worse.
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This brings us to the concerns of the central bank of India, the Reserve Bank of India, which published its latest bimonthly review of monetary policy last week.
The RBI is, by law, required to keep the retail inflation rate within a band of 2% and 6%. At the start of the Covid breakout in late March and again in late May, the RBI furiously cut interest rates to boost economic activity, while largely ignoring the tightening of the retail inflation rate. Governor Shaktikanta Das made it clear that the RBI will do everything in its power to jumpstart growth.
But in the last three policy reviews, including the last one, the RBI’s Monetary Policy Committee has decided to keep the policy’s benchmark interest rate, the buyback rate, or the interest rate at which it lends money to banks. . unchanged.
For those who follow monetary policy closely, this decision was a foregone conclusion even before the RBI announced it.
Why?
Because even though India’s economy is struggling to grow, the retail inflation rate, calculated using the consumer price index, had remained above the RBI’s comfort zone for almost every month since last November. (see Graph 1).
Retail inflation has been outside RBI’s comfort zone for the 12 months
Before the December 4 policy announcement, most people believed, as in November and December of last year, that it is only a matter of time before retail inflation falls, and when it does, the RBI will restart by cutting prices. interest rates to boost the economy. exercise.
But here lies the most important conclusion of the latest monetary policy review: At last, the RBI admits that, far from improving, the inflation outlook is worsening. “The inflation outlook has turned adverse relative to expectations in the last two months,” the policy statement stated. As a result, the RBI has substantially raised its inflation forecast not only for the current quarter (October to December) but also for the two quarters after this: January to March and April to June in 2021.
Look at Table 2. It was taken from the latest “Professional Forecasters Survey on Macroeconomic Indicators” from the RBI. Figures in parentheses show the extent of the revisions. As can be seen from a sea of positive signs, forecasters have upped their inflation forecasts across the board, be it retail or wholesale, general or core, this quarter or two quarters.
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The data comes from RBI’s latest “Professional Forecasters Survey on Macroeconomic Indicators.”
Table 3, which was taken from the latest RBI “Consumer Confidence Survey”, is also quite revealing as it shows that, in the coming year, consumers are optimistic about all macroeconomic variables except the issue of prices. .
Data is taken from RBI’s latest “Consumer Confidence Survey”
The result of the RBI’s assessment of the economy was that, while growth is picking up, it is not as broad, and inflation is rising and becoming broader.
The question some of you may rightly ask is: Why hasn’t the RBI increased interest rates? Are you not required by law to maintain price stability?
This is a valid query. After all, if one looks at Graph 1, it is clear that in the last 12 months not only has the headline inflation rate been outside the RBI’s comfort zone, but food inflation has also routinely touched double digits. Worst of all, even the core inflation rate, or the inflation rate after excluding food and fuel prices (which fluctuate quite a bit), has continued to rise throughout the year and now threatens to exceed set levels. for headline inflation. .
A large part of the answer to this question lies in understanding why inflation is high in India and whether increasing buyback rates is the solution. As the RBI notes, the ongoing inflation spiral is being fueled by supply chain disruptions, excessive margins, and indirect taxes.
For example, if fuel prices are higher because the government continues to increase indirect taxes on them, to what extent will increasing the buyback rate drive down fuel prices?
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Similarly, if the price of a good is higher today because the supply of goods is disrupted thanks to Covid, can higher buyback rates drive prices down?
If the cause of the current inflation spike was excessive demand – “too much money chasing too few goods” – then rising interest rates might have helped things. Higher interest rates would have kept enough people away from spending and investing, thus lowering the price level.
But that is not happening today. Industrial growth is almost non-existent (see graph 4) and the contracting of credit is anemic (see graph 5). Capacity utilization in companies is low and they are laying off employees to cut costs.
Industrial growth is almost non-existent
Also, even raising or cutting buyback rates usually takes some time, at least a quarter, before influencing the market interest rates paid to you and me.
That is why central banks are more concerned with managing people’s expectations of future inflation rather than reacting to monthly inflationary movements.
If raising interest rates is not effective, what is the way to cool prices?
Credit withdrawal is anemic
The RBI underscores the need for “proactive supply management strategies. “More efforts are needed to mitigate supply-driven inflationary pressures,” he says.
Who will do this? Of course, the government. The RBI is already doing the best it can: it is not raising interest rates, even when all types of inflation parameters are off the charts.
One year later, India still cannot be characterized as facing stagflation. While GDP growth is expected to rebound, persistently high inflation is becoming a concern that cannot be dismissed as seasonal or transitory.
Stay safe,
Udit
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