What’s wrong with monetary policy in India? Interest rate not the only tool, these things too matter

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Updated: April 3, 2019 4:25:56 PM

Moreover, India has been pursuing bad macro policies for generations, and monetary policy has become less effective with time with other forces also determining the rate of inflation, said Surjit Bhalla, veteran economist and former member of Prime Minister’s Economic Advisory Council.

The Reserve Bank of India’s latest review meeting to discuss the first bi-monthly monetary policy of 2019-20 has once again ignited the debate on the appropriateness of the monetary policy framework in India. The concerns raised by experts range from effective transmission of monetary policy to managing inflationary expectations to macro economic policies.

As the RBI’s Monetary Policy Committee began its 3-day review meet yesterday, Former Chief Economic Advisor Arvind Virmani raised concerns about the impact of high real interest rates on investment and consumption. He also flagged the liquidity problem in the economy, while speaking at an event in New Delhi.

Arvind Virmani took a dig at Urjit Patel and Raghuram Rajan, categorically expressing his discontent with the strategy followed by the two former governors of the RBI. “I would like to disagree with the previous two RBI governors on their failure to recognise the difference between temporary and permanent shocks. Temporary shocks need to be accommodated and anticipated, and the public needs to be educated about its ineffectiveness to affect inflationary expectations,’’ he said at a Shadow Monetary Policy panel discussion organised by EGROW Foundation and Assocham.

Another rate cut on anvil

Many are expecting a further repo rate cut by the RBI Monetary Policy Committee to give a boost to the economy, when it unveils this financial year’s first Monetary and Credit Policy tomorrow. A Reuters poll of economists expects the MPC to cut the repo rate by 25 basis points to 6% — the lowest since 2010. However, experts explained why even a rate cut would not suffice to bring down interest rates in the economy.

“It becomes really important to see if the transmission is actually happening, otherwise it becomes a redundant rate reduction,” said Upasna Bhardwaj, Vice President – Treasury and senior economist at Kotak Mahindra Bank.
Liquidity stance and policy stance must talk to each other, which needs coordination between both RBI and MPC, for smoother transmission of policy rates in the economy, she said. Liquidity management has suffered in the past due to demonetisation and negative balance of payments. However, there are some signs of improvement with the aggressive open market operations and new swap window opened by the RBI, she added.

Structural issues

Moreover, India has been pursuing bad macro policies for generations, and monetary policy has become less effective with time with other forces also determining the rate of inflation, said Surjit Bhalla, veteran economist and former member of Prime Minister’s Economic Advisory Council. Each country in the global economy has to compete in terms of capital and corporate tax rate, he added.

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Meanwhile, Charan Singh, chief executive and director of EGROW Foundation, made a case for disaggregate banking system into commercial banking on one side, with infrastructure lending on the other side, given that most of the banks’ NPAs were from the infrastructure sector. “if there had been developmental financial institutions, these NPAs which restricted the credit flow to industry could have been taken care of,” Charan Singh said.

A reduction in SLR and expanding the scope of priority sector lending were also among the other suggestions floated during the discussion.

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