With the monetary policy committee (MPC) meetings underway and the Reserve Bank of India (RBI) governor Sanjay Malhotra’s policy statement on April 8th, concerns are running high on the stance the central bank will take.
This writer approached veteran banker Dinesh Kumar Khara, the former chairman of the State Bank of India and a highly regarded voice in the banking arena on what he felt would be on top of the agenda items for the MPC and what could be expected in the monetary policy?
Khara clearly sees addressing the concerns on imported inflation as a key focus item and in the light of this how to provide cushion to vulnerable sections of the economy, especially the small and medium enterprises. This, he sees, as factors that are most likely to colour and define the monetary policy stance of the RBI.
Goldilocks confused
The worries on imported inflation have been triggered by factors outside the control of the central bank. That it is already impacting the hard-earned Goldilocks glow of the economy is already a matter of concern. There are now real risks to the projected growth of 7- 7.4 per cent for 2026-27 on top of low inflation.
This comes close on the heels of the previous calendar year closing with what the RBI governor described as “a rare Goldilocks period” of high growth and low inflation. As per Khara’s estimate, the imported inflation could now mean over 6 per cent in a quarter or so from now.
So, what makes the worry on imported inflation real? It is well past the question of the fall out due to a ‘prolonged conflict’ in the Middle East as the adverse impact is already being felt. The imported inflation has been triggered by the rise in the crude oil prices (staying sticky at over $ 100 a barrel).
Addressing these concerns while staying supportive of growth will perhaps be engaging the monetary policy committee ahead of the policy statement on April 8th. This, Khara feels, may entail discussions around ways to mitigate the risks for small and medium enterprises (SMEs).
Domestic demand
The imported inflation will show up in the cost of living going up and purchasing power reducing for essentials. There could therefore be a risk for domestic demand also even in the short run. Khara estimates imported inflation impact could almost double the current inflation “to over 6 per cent. These are difficult days, particularly in the context of crude oil.”
The impact of the developments in the Middle East have often been compared to the hit on the economy during the pandemic.
“When I compare these with challenges faced during Covid-19 it is hard not to miss the fact that even during the pandemic the price of crude did not increase as high as is the case today and because the economic activity was low globally during the pandemic there was also no demand for crude and to that extent this black swan event of the unfolding conflict in the Middle East could prove more damaging,” he feels.
Supply chains
The impact of snarls in the supply chain lends an added layer of worry and this is already being felt by the shortages across sectors – from fertilisers to healthcare. For instance, supplies of liquid helium have been hit. It is used as a coolant in the MRI scanners (and also by the semiconductor industry) and this has already been flagged by players in the healthcare sector.
Khara however reminds that the government and the central bank seem to be having their ears close to the ground and are trying very hard to address the challenges.
For instance, the RBI has taken concrete measures to arrest the fall of rupee against the dollar by imposing a cap on net open rupee position of banks at $ 100 million per day as against the earlier system where positions equivalent to 25 per cent of their capital was permitted and this made arbitrage opportunities available for banks.
Now this has been restricted and the resulting check in the fall of the rupee will help cut down on the imported inflation too.
While at the moment, the government has absorbed the spurt in crude price hike for the end consumer and announced the excise duty cut on petrol and diesel. But this, over a longer duration, could start impacting the fiscal probity goals of the government.
If the fiscal deficit increases it will reflect in increased government borrowing and the base level for interest rates will go up because of higher borrowings (higher supply of government bonds).
Fiscal concerns
On top of it, there is already the challenge for the current account because of increased outflow of funds on account of rise in crude price, adverse impact on inward remittances and this is coupled with outflow of foreign institutional investments and FPIs – estimated to the tune of around almost Rs 1 trillion.
Independent industry estimates suggest the six GCC (Gulf Cooperation Council) countries contribute to almost 38 per cent of total inward remittances at around $ 50 billion into the country.
This is crucial for India since inward remittances account for a major source of external financing (the second largest source after the export of services) and therefore play an important role in reducing the current account deficit.
In terms of the monetary policy stance, Khara does not foresee any change in the interest rate. But given that there is limited elbow room in terms of tinkering with the SLR. There could be some reliefs announced for the SMEs or perhaps for the NBFCs and encouraging banks to support the NBFCs. The measures could be supportive in nature like those extended earlier to the exporters.