India’s central bank is in an enviable position. Unlike central banks in major economies that are struggling to maintain their monetary policy stance, the Reserve Bank of India’s journey of non disruptive gradual policy accommodation that it embarked upon in January 2015, continues rather smoothly. In this context, it is important to highlight two welcome divergences with other central banks.
RBI in a sweet spot
First, major central banks are grappling with unorthodox monetary policies and its impact on their currency, which usually helps to foster competitive depreciation of their respective exchange rate. In contrast, India’s gradual approach towards monetary easing has helped in supporting growth conditions in a subdued global growth environment. This has resulted in a somewhat stronger currency on REER basis.
Second, the empirical evidence on NIRP and QE policy adopted by many central banks is mixed at best. This has led to some discord within central bankers, which is now getting manifested via a difference in opinion at the monetary policy table. In contrast, RBI’s fourth bi-monthly monetary policy review stands out in comparison. The maiden policy decision under the aegis of the Monetary Policy Committee was unanimous, in contrast to the division seen in street expectations. The absence of a dissenting voice in the MPC, comprising of 3 RBI insiders and 3 external experts nominated by the government, shows harmony in economic and financial assessment and complete confidence in the central bank’s ability to meet the government’s notified long term inflation target of 4%.
The small and the big picture on inflation has changed
This healthy decoupling for India’s central bank over the last few quarters is premised on the gradually improving growth-inflation mix.
Take for example, the agriculture outlook. After a two consecutive years of monsoon deficiency, a normal outturn for 2016 south-west monsoon bodes well for both growth and inflation. Total foodgrains production in 2016-17 kharif season is projected to touch a record high of 135.03 mn tonnes, exceeding the full year target by 2.28 mn tonnes. Led by pulses, oilseeds, and coarse cereals, growth in foodgrains production is expected to touch 8.9% in the year 2016-17 vis-à-vis a dismal average growth of -1.9% seen in the previous two years.
This will not only provide about 40-50 bps incremental support to headline GDP growth, it will also help in keeping food inflation under check. The seasonal sequential correction in food prices has already commenced. This will gain further momentum as the kharif output comes on board in the coming months. As such, CPI inflation could potentially dip to 4.0-4.5% in Q3 FY17, much lower than RBI’s status quo projection of 5.0%. Going forward, Q4 FY17 inflation could also carry a downward bias due to late withdrawal of monsoon, which is likely to help in maintaining healthy ground water levels and moisture content for the upcoming rabi sowing season. This will create further space for incremental monetary easing before end FY17.
Having said that, it is important to note that the factors behind the gradual disinflation story for India goes beyond short term cyclical enablers like monsoon. A prudent use of policy on procurement prices, timely liquidation of excess buffer stock, effort towards creating a National Agriculture Market, budgetary focus on irrigation, etc. are steps which would impart administrative and structural efficiency to the food economy. Last but not the least, institutional reforms like the Insolvency and Bankruptcy Code and the GST would further enhance economic productivity and unlock potential sources of disinflation from the industry in the medium term.
The big picture on inflation has evolved favorably in the last two years. India is the only major economy in the world which has been meeting its inflation target rather comfortably. Going ahead, persistence on reforms will make it possible to meet the long term inflation target without invoking the sacrifice ratio.
(Rao and Kumar are chief economist and senior economist, respectively, at YES Bank)