By Chinmay Joshi
Central banks across the world have been grappling with elevated price levels and dwindling growth. In India, too, the Reserve Bank of India (RBI) being a central bank of the country finds itself in a similar quandary where it is expected to navigate the economy successfully amidst the lacklustre economic growth and persistence of rising inflationary pressures. The data released by the Second Advance Estimates (SAE) on February 28, 2023, as well as predictions made in the Economic Survey 2022-23 regarding the real growth rate in the ensuing period, have necessitated the monetary policy committee (MPC) of RBI to calibrate its monetary policy in such a way that it gives priority to growth concerns despite the ordinary success in anchoring headline inflation around the target level set out under the flexible inflation targeting (FIT) mechanism i.e., 4% (+/-2%).
The MPC of RBI, on April 06, 2023, announced its first monetary policy resolution (MPR) of the fiscal year 2023-24 and resorted to maintaining the policy repo rate unchanged at 6.5% and along with maintaining the ‘withdrawal of accommodation’ stance while supporting growth. Though the RBI Governor indicated in his statement that this pause is temporary, such a policy resolution exhibits RBI’s changing focus where supporting growth revival now seems to be a primary objective while anchoring inflation expectations seems to have taken a backseat.
The Union Budget for 2023-24 sought to address the issues regarding the falling economic growth rate by adopting the expansionary fiscal policy. Several measures announced in the budget such as augmenting capital expenditure, boosting infrastructure development, supporting the green economy, and introducing various changes in the tax slabs along with other supportive measures will prove beneficial to revive the decelerating economic growth. Adoption of a pause in policy repo rate hike, amidst the recent banking turmoil in the USA and Europe, will also support such growth concerns by reducing the rising credit costs along with easing some liquidity concerns in the economy. Dovish monetary policy in tandem with the expansionary fiscal policy will be helpful in providing the required fillip to the sagging economic growth.
Notwithstanding, it should be worthwhile to note that the imminent threat to such a pause will invariably come from highly volatile international energy prices, especially Brent crude oil prices. RBI, in its MPR, has assumed that the oil prices will remain at around 85 US$ per barrel. However, deteriorating geo-political and economic conditions around the world will certainly lead to an increase in Brent crude oil prices above 85 US$ per barrel. In this regard, careful attention is required to be paid to the fact that the Organization of Petroleum Exporting Countries (OPEC) + countries have decided to cut oil production by more than 1 million barrels per day which has the potential to cause a surge in the oil prices worldwide. Various analysts and industry experts are of the view that oil prices may reach around 100 US$ per barrel in near future as an impact of the current OPEC+ production cuts. This will significantly dent India’s fight against inflation as inflation emanating from fuel and related commodities cause a substantial increase in overall headline inflation. In March 2023, headline inflation in India was recorded at 5.66% whereas the inflation for fuel and light was recorded at 8.91% in the same month. In this context, it is also important to note that fuel inflation has been the highest among all other components of headline inflation in most of the period during the last one year (Chart 1).
Additionally, the rising tensions in the Middle East countries especially between Israel and surrounding Arab nations will add fuel to the fire. As per some estimates, India has been importing around 60% of its overall crude oil requirement from the Persian Gulf countries for the past few years. This is of great significance as India imports more than 80% of its oil requirements from abroad. Such imported inflation will increase India’s import bills. Subsequently, it will put additional strain on India’s trade and current account balance leading to erosion of the recent exuberance of narrowing of the current account deficit (CAD) in Q3 of 2022-23.
Significant volatility in international energy prices, lingering geo-political tensions, risks of rising food prices as a result of unseasonal rains and hailstorms, and predictions of ‘below normal’ monsoon due to the possibility of El-Nino effect together will have downside implications for headline inflation going ahead. Furthermore, the core inflation has still remained at an elevated level and is expected to be sticky. Keeping this in mind, the MPC-RBI should strive to bring down the headline inflation level to 4% as mandated under the FIT rather than maintaining the headline inflation level around the upper limit (6%) of the target level in the upcoming MPRs. It should be vigilant as the inflation threat is far from over despite some temporary respite being available in the form of softening of the headline as well as wholesale price index (WPI) inflation in the recent past.
In order to boost economic growth, the government has already adopted an expansionary fiscal policy through the Union Budget 2023-24. RBI too has tried to play a supportive role to the government by avoiding adopting a tight monetary policy. MPC-RBI should be cautious in adopting MPRs giving priority to growth since expansionary fiscal policy along with the dovish monetary policy has the potential to adversely impact the price level. Rising inflationary pressures will be detrimental, particularly to the poor class of society, eroding their purchasing power and pushing them into the abyss of poverty. In this context, it would be pertinent to quote, Dr Ludwig Von Mises, an Austrian Economist, “Continued inflation inevitably leads to catastrophe.”
(Chinmay Joshi is Academic Associate, Finance and Economics at Bhavan’s SPJIMR. Views expressed are author’s own.)