Plus ca change, plus c’est la même chose.’ (The more things change, the more they stay the same). When Jean Baptiste Alphonse Karr, the 19th century French journalist and novelist, wrote those oft-quoted words, he could never have dreamt that his aphorism would, one day, serve as, perhaps, an apt description of the Monetary Policy Committee’s (MPC) resolution of June 2021.
Consider. The situation today is far removed from what it was a year ago. There has been a fundamental shift in the growth-inflation mix. Economists might argue till kingdom come about the trade-offs, but there can be no disputing facts. Growth impulses have steadily declined (the MPC lowered its gross domestic product projection for the year from 10.5% earlier to 9.5%), even as inflationary pressures and expectations have risen, suggesting monetary policy has reached its limits.
Yet, faced with a second and more ferocious wave of the pandemic, the MPC opted to keep the policy (repo) rate unchanged at 4% and retain its accommodative stance. For the sixth straight time!
This is not surprising. Over the course of last year, more specifically after its October 2020 meet, when it gave a time-based forward guidance, the MPC has painted itself into a corner. Thanks to its policy of consistently favouring growth over inflation, regardless of gathering storm clouds on the price front, or indeed, much thought to whether its policy was achieving the stated goal of incentivising growth, it was left with no wiggle room.
Any other action would have risked rocking the boat, since the MPC has, all along, lulled markets into believing it will remain accommodative for as long as growth is anaemic. What it could have done, but singularly failed to do, is remind (warn?) markets in its commentary that monetary policy is not, and cannot be, a one-way street. Not when the underlying macro-mix has changed.
Rewind to June 2020. When the MPC embarked on its aggressive easing cycle (with a 40 basis points cut in the repo rate), after its first out-of-cycle meet in May 2020, we were struggling against the first wave of the pandemic. Economic activity had come to a standstill thanks to the strict nationwide lockdown from March 2020. The world economy was in the doldrums, as the virus laid Western economies low. The outlook on inflation, in the words of the Reserve Bank of India (RBI) governor, was expected to be “benign” (minutes of May 2020 MPC meet). The government had announced some measures to support the economy. But these were puny and largely non-fund based. So monetary policy had to, perforce, take the lead.
Fast forward to June 2021. The second wave of the pandemic has seen the nationwide lockdown replaced by localized lockdowns, the timing and intensity varying by the spread and ferocity of the pandemic across different regions. Unlike last time round, when the lifting of the lockdown was expected to see a sharp increase in consumption, thanks to pent-up demand, this time there is no such certainty, thanks to the prevailing fear factor in the absence of an effective programme of covid vaccination.
Meanwhile, inflation has begun to inch up in no uncertain manner. According to RBI’s Annual Report 2020-21, inflation averaged 6.2% last year (above the upper end of the target band of 2-6%). Today, core inflation (excluding food and fuel) is both high and sticky. Global commodity prices have risen by an average of 80% since the low of April 2020, even as the long-term impact of unconventional fiscal and monetary easing spills over into higher consumer prices. In April, the US recorded its highest inflation in 13 years. In such a scenario, the MPC’s inflation projection (5.1%) looks highly optimistic (unrealistic?).
At the same time, true to the law of diminishing returns, monetary policy in India has failed to move the needle on credit growth. Manufacturing activity dropped to its lowest in 10 months in May and consumer sentiment has declined. Despite the RBI keeping the system flush with liquidity for over a year. Or, on occasion, delivering below-the-belt punches to the bond market to keep interest rates on government borrowings (and hence on interest rates in the system) low.
Remember, regardless of whether inflation is driven by demand-side factors (read, excess demand) or supply side factors (read, cost-push and supply disruptions), once inflation and inflationary expectations become entrenched, monetary policy has only one weapon in its toolkit – higher interest rates.
From the days when monetary policy was forced to lead the effort to revive economic growth, since the fisc seemed strangely reluctant to do its bit, its role has, perforce, become increasingly less effective, as evident from RBI’s inability to keep bond yields low on a durable basis. Or incentivize credit-offtake. Monetary policy has reached its limits. Any further action would be like pushing on a string.
Agreed, the MPC’s hands were tied for many reasons, primarily its past action/inaction. But by ignoring the changed ground realities and its implications for the evolving growth-inflation mix in its commentary, it lost an invaluable opportunity to warn markets that monetary policy is not, and cannot be, a one-way street.
Mythili Bhusnurmath is a senior journalist and former central banker.
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