RBI doesn’t have much comfort room, but it is using the tools it has; the govt must now pull its weight on supporting growth
RBI did well to keep policy rates on hold last Friday and to make it abundantly clear it was not about to abandon its accommodative stance in a hurry. Indeed, Governor Shaktikanta Das went out of his way to assert that the stance would remain accommodative as long as it was needed and that it is premature to think about reversing it. To be sure, economists are anxious about rising prices, and have pointed out that the central bank is ignoring inflationary pressures that could pose problems for the economy later on.
When confronted with the question, RBI said in its defence that inflation currently is being influenced primarily by supply-side factors rather than any demand pull. Indeed, the central bank tweaked its inflation forecasts a wee bit, raising it to 5.1% from 5% earlier. It is quite possible, as some economists have argued, that while input prices have gone up for manufacturers, they have so far not passed these on to consumers probably for fear of losing market-share.
They argue that once demand firms up, the higher input costs would be passed on to the end-consumer, thereby stoking inflationary pressures. It is probably also true that the central bank has also been charged with staying accommodative for too long and thereby has been left with virtually no room to pull back.
However, even as the MPC’s mandate requires it to respond to inflation, these are extraordinary times, and while the ferocious second wave of the pandemic may be tapering off, one cannot rule out a third wave. That the economy has been completely battered and that there is very little chance of a meaningful recovery—for a large swathe of the population—in the near term is now evident. The central bank lowered its GDP growth forecast for FY22 to 9.5% from 10.5% earlier; at this pace of growth, the economy would be more or less at the same levels that it was at the end of March 2020.
At a time like this, it is important RBI makes sure the government’s large borrowing programme is completed and that the funds are mopped up at affordable rates, so that the latter can spend as planned. Indeed, the central bank has little option but to leave liquidity loose for some more time because, without spending, there is no way to tackle the low consumer confidence given the poor investment appetite of the private sector.
Only if the benchmark bond yields are reined in can interest rates for companies be kept in check. The large corporates are cash-rich and may not need to borrow too much, but there are thousands of small enterprises struggling to make ends meet; for them, even a 10-basis-points hike in interest rates could hurt badly. Fortunately, inflation is well within the upper limit of 6% though the sharp hikes in the prices of auto fuels locally and the elevated prices of commodities globally are worrying.
RBI doesn’t have too much comfort room, but it is using various tools—including the new GSAP—to make sure that liquidity remains adequate. Indeed, the government shouldn’t worry too much about deviating from the fiscal deficit target for FY22 and continue to spend to revive the economy. Unless growth picks up quickly, it will become increasing harder to revive the momentum. RBI’s moving in the right direction; now the government needs to get going. Without some big fiscal stimulus, growth cannot make a comeback.