Monetary policy is an important tool in any economy and especially so when an announcement follows the first Budget of the new government. The fiscal policy stance as delineated in the Union Budget is supportive of growth, employment generation and fiscal consolidation imparting confidence to the market about the direction that would be pursued in the next few years.
The global scenario is not so clear. The global growth rate estimates for 2014 have been lowered by the IMF because of weak performance in the US as well as in a number of emerging countries. The downside geopolitical risks continue to cloud global markets in addition to the continuation of tapering by the US Fed and announcement of negative policy rates by the ECB.
Amidst such a mixed economic situation, the recent monetary policy announced by RBI has continued with its high policy rates which were raised in the first place on the basis of high inflation. Despite the fact that inflation measured by the consumer price index (CPI) has moderated for two months, wholesale price index (WPI) is also recording lower rates and the progress of monsoon has been satisfactory, the policy rate has not been lowered. The heightened interest rates have been maintained, arguably for encouraging savings and holding interest rates in the positive zone.
In sharp contrast, to encourage economic growth, real policy rates continue to be in the negative zone in the euro area, Japan, the US and the UK. In India, given that unemployment is high amongst the youth, growth and employment probably need to be explicitly factored in the monetary policy matrix.
The reading of the monetary policy statement, with just two fan charts, clearly indicates that RBI is embarking on a regime of implicit inflation targeting, even if not explicitly stated. The hallmark of inflation targeting is transparency and clear communication. In view of the shrinking volume of information in the recent months that was traditionally released earlier along with the monetary policy, probably there is need to regularly have a report like the Beige Book (BB) of the US Fed (implicit inflation targeter) or a monthly Agents? Summary of Business Conditions (ASBC) and quarterly Inflation Report (QIR) of the Bank of England (explicit inflation targeter).
The BB is released eight times every year, synchronised with every Fed meeting, and summarises anecdotal information on current economic conditions in each of the 12 districts of the US. The BB is prepared based on extensive research and interviews with key business contacts, economists, market experts and other sources.
The ASBC is a summary of monthly reports compiled by the Bank of England?s Agents for the Monetary Policy Committee, following discussions with around 700 businesses from firms across all sectors of the economy.
The QIR presents a detailed analysis of the economy in terms of demand, output, costs, prices, risks and inflation projections for the UK economy.
The recent positive trend in the manufacturing sector, supported by RBI surveys on quarterly order books, inventories and capacity utilisation, and industrial outlook, needs to be carefully analysed. Illustratively, industry experts inform that the growth in sales of cars and SUVs is mainly because of the pent-up and postponed demand of yesteryears based on a lower base of the previous year. And most of it is replacement of fleets by major players. The sale figures of trucks continue to be rather dismal with sales plunging to about 50% of the peak last year, according to market reports.
It would have been helpful for the researchers if some information on rising non-performing assets (NPAs) in public sector banks was presented, especially after the government had expressed concerns in the Union Budget. The reasons for high NPAs, amongst others, are the slowdown of the economy and unhedged foreign exchange exposures by a number of firms. In a number of cases, again according to market anecdotes, large volumes of performing assets are window dressed to look evergreen by ensuring 2-3 instalments in a year. Therefore, constituting a high level technical committee to analyse causes of rising NPAs, especially in infrastructure sector, would inspire confidence of the markets.
India, unlike the US of Paul Volcker, or that of other advanced countries, never witnessed great moderation since the 1990s. For example, in the last three decades, inflation was above 6% in 22 years when measured by average CPI (industrial workers) and 18 years according to WPI. In an emerging country, in transition, in the cusp of reaping demographic dividends, and with imperfect markets and supply-side constraints, inflationary pressures are bound to emerge regularly. The policymakers need to consider whether Indian population has the resilience of facing a recession in absence of social security and universal pension, unlike the US in 1982 following Volcker?s hawkish monetary policy.
Arguably, despite waning inflation, low growth, rising unemployment and higher investment under SLR bonds, not lowering interest rates, on the premise of known and unknown risks, monetary policy could be termed as lazy central banking! In contrast, a quarter percent cut in the interest rates could have sustained the growth impulse imparted by the fiscal policy and allowed the green shoots to blossom.
The author is RBI Chair Professor of Economics, IIM Bangalore.
Views are personal