By Churchil Bhatt
“He didn’t say for sure he’d come. And if he doesn’t come? We’ll come back tomorrow. And then day after tomorrow … And so on.” These are the lines from Samuel Beckett’s ‘Waiting for Godot’ in which two characters engage in a variety of discussions in anticipation of meeting Godot, who never arrives. The current monetary policy landscape is reminiscent of Samuel’s absurdist tragicomedy in which almost every market player is waiting for “Godot” – an elusive being with the definitive resolution who simply refuses to show up. People are waiting for the end of Covid, Central Banks are waiting for the elusive “durable, employment driven growth”, and bond markets are waiting for a return to conventional market dynamics where predicting policy action was less complicated.
Since March 2020, policymakers have introduced ultra-easy accommodative policies to limit the costs of Covid. Lower interest rates and excessive money printing have pushed a large part of this liquidity into asset markets, propping up asset valuations far ahead of real economic growth. Of late, growth is beginning to catch up with assets as economies reopen. But recovery in economic activity and structural supply constraints have also led to a sharp rise in inflation.
Under normal circumstances, the policy makers are expected to fine-tune the level of their policy accommodation in response to evolving growth-inflation dynamics. But not today, when they are still waiting for “durable growth” post a Global Pandemic. Hence, Central Banks are forced to confront a “transitory” phase of very high inflation while they resolve to support the economic recovery doing “whatever it takes”.
Central banks may draw some comfort from the transitory inflation hypothesis based on recent history. The period ensuing Quantitative Easing post the Global Financial Crisis suggests that inflation had failed to be a problem then. Looking at Japan’s stint with deflation for decades, there may also be a feeling that deflation is a much harder problem to manage than inflation. In fact, for most of recent history, growth has been a more persistent problem than inflation. At the same time, Central Banks would also remain wary of fostering conditions where inflation is no more “transitory”. After all, too much monetary accommodation for too long may also have some unintended consequences.
Therein lies the Central Banker’s dilemma. How long to persist with extra-ordinary accommodation as they wait for “durable growth”? For how long can they dub the inflation as “transitory” before it starts hurting the most vulnerable? How to adequately prepare the markets for managing a non-disruptive, gradual withdrawal of accommodation? After all, an untimely rise in policy rates may also pose a challenge to sustainability of large government debts and disrupt asset markets. Given the recent rebound in growth and inflation, policy normalization may look inevitable. But until Central Banks meet the objective of “durable growth” and prepare the markets for taper, it may not be the time to change the status quo.
In this context, the upcoming MPC meeting will see the RBI navigate through the thin line between supporting the nascent growth revival and addressing the concerns about inflation. The MPC is likely to reaffirm its growth focus suggesting that ‘a durable increase in aggregate demand is yet to take shape’. RBI governor has already opined that recent elevated inflation readings are a ‘transitory hump’. The committee may draw comfort from the fact that headline CPI inflation is likely to revert back into the MPC’s target band from July onwards.
With monsoons picking up pace, the outlook for food inflation also looks promising. A status quo, wait and watch policy yet again may look boring, but it is the need of the hour. We therefore see merit in the MPC persisting with its accommodative policy stance, as it prepares markets for a gradual normalization in surplus liquidity and strives for an orderly evolution of the yield curve using its available toolkit. Yet again, we are waiting for Godot.
(Churchil Bhatt is EVP Debt Investments, Kotak Mahindra Life Insurance Company. Views expressed are the author’s own.)