Once more into the breach, as they say. Yet again, contrary to Street expectations, RBI hiked repo rates. Various trade-offs overlay the decision.
Over the past few days, concerns on emerging markets volatility have again resurfaced, with various central banks either raising rates or not cutting them, as widely expected. In an increasingly interconnected world, vulnerable to capital surges, both inflows and outflows, there has to be a degree of coordination between emerging markets policymakers to ensure that any one specific country is not subject to volatility driven by arbitrage flows.
In addition, new data based on RBI surveys on inflation expectations, business confidence, capacity utilisation and inventory levels also suggest that business is reviving, however moderately, with the potential to translate into higher core inflation.
One of the reasons why there was a divergence in market expectations and RBI actions was the assumption behind the one-year-ahead inflation trajectory. RBI projections, it turned out, were conditional on a 25 basis point (bps) repo rate increase, whereas ours was non-conditional.
But one trade-off the Governor was quite emphatic on: “The so-called trade-off between inflation and growth is a false trade-off in the long run.” The reasons for this statement were laid out clearly in the preceding paragraph of his statement. There is also no question whatsoever that high inflation—whatever the economic context—signals excess demand and is adverse to growth through a potential wage price spiral set off by inflation expectations.
This brings us to the recommendations of the Urjit Patel committee report, whose philosophy is consistent with the aforesaid statement. The report itself is an excellent read, an analytically oriented scaffolding to move India’s monetary policy decisioning to a modern, deliberative framework, in line with best practices in much of the developed world, and increasingly in emerging markets.
Much has already been written on the salient points of the committee report. In particular, the lure of inflation-targeting in terms of providing a quantifiable objective and in imparting clarity and a measure of certainty to the choice of instrument is unquestionable. What has been the global experience of inflation-targeting? The accompanying table, sourced from a Sweden Central Bank research document (cited below), shows the effects of inflation-targeting across countries, in the two periods (pre-crisis) 2000-06 and (post-crisis) 2007-12, grouped into developed and emerging markets.
For developed markets (DMs), the evidence is a bit puzzling. In both the pre- and post-crisis periods, inflation had been higher for inflation-targeting DMs (and