With the sticky retail inflation print suggesting that the Reserve Bank of India (RBI) is likely to continue hiking interest rates, there are early but discernible signs of a divergence of views between the government and the central bank on the latter’s monetary action to check inflation versus the former’s imperative to rekindle growth.
Amid sluggish employment trends, subdued private investment and the challenge of sustaining the nascent consumption recovery, there are multiple signals that North Block is leaning in favour of a benign pace of rate hikes by the RBI rather than the aggressive stand taken by central banks of developed countries.
The government’s view is that in the wake of the continuing Russia-Ukraine conflict, inflation is driven mainly by global factors. “Until recently, inflation was a concern, largely due to external factors which are now cooling off,” a top government official said.
Seasonal factors affect prices of food items, but many of these items are well stocked, the official added. Also, there is a growing recognition of employment growth not keeping pace. “Even though growth has picked up after the pandemic, the employment elasticity is lower and it is a concern,” another official said. With many agencies cutting their growth forecasts for India, the concern in the government is that any sharp hike in rates may dampen growth prospects.
The RBI is in a bind. It is just one month short of overshooting its inflation target for three consecutive quarters following which it will have to formally explain the reasons for the breach in its inflation target to the government. The RBI is planning to hold a special meeting of the Monetary Policy Committee after the next inflation print comes on October 12 to discuss the report it will have to submit to the government.
The recent retail inflation print for August came in at 7 per cent, marking the eighth month above the upper threshold of the RBI’s target of 4 +/- 2 per cent, and almost three years (35 months) of staying above 4 per cent. From the central bank’s perspective, easing up right now, according to an official familiar with multiple discussions on this issue, isn’t a feasible strategy.
Last month, the RBI announced a third repo rate hike to 5.4% — a raise of 140 bps since May.
On Friday, the RBI, as part of its State of the Economy bulletin, favoured a “frontloading of monetary policy actions,” such as interest rate hikes, to contain inflationary pressures without sacrificing “medium-term growth” prospects. The RBI, however, underlined that the opinions expressed in the article were those of the authors, which included Deputy Governor Michael D. Patra.
On September 8, speaking at an ICRIER conference, Union Finance Minister Nirmala Sitharaman spelled out the challenge with a disclaimer. “The Reserve Bank will have to synchronise somewhat, may not be synchronised as much as developed central banks. I am not prescribing anything to the Reserve Bank, I am not giving any forward direction to the central bank. But it is the truth — India’s solution to handling the economy, part of which is handling inflation also, is an exercise where the fiscal policy together with monetary policy has been at work. It can’t be singularly left to monetary policy, which has proved totally ineffective in many countries. And these are countries whose structures form the basis for monetary policy theory, that interest rates are the potent tool to manage inflation,” she said.
A day earlier, speaking at the India Ideas Summit organised by the US-India Business Council (USIBC), the FM had said that inflation has been brought down to manageable levels and is no more a “red-lettered” priority. “Red-lettered ones would of course be jobs, equitable wealth distribution and making sure India is moving on the path of growth. In that sense, inflation is not red-lettered. I hope it doesn’t surprise many of you. We have shown in the past couple of months that we were able to bring it to a manageable level,” she said.
Earlier this week, in a discussion on the book written with Finance Commission chairman N K Singh, Principal Secretary to Prime Minister P K Mishra spoke along similar lines on the need to structure policy beyond the “one-dimensional” focus on inflation.
In its latest monthly economic review released Saturday, the Finance Ministry said it is expecting the pickup in consumption to sustain and that a sharp rebound in private consumption backed by soaring consumer sentiments and rising employment “will sustain growth in the months ahead”. A high interest rate cycle typically affects consumption and investment sentiment.
Queries sent to the Finance Ministry and the RBI on the issue by The Indian Express went unanswered.
The difference in views between North Block and Mint Street on the issue of rate hikes is not new. In April 2015, even after two interest rate cuts that year by the RBI, then Finance Minister Arun Jaitley had said he wanted the interest rate to be “a lot lower”, noting that there were no differences between the government and the RBI.
Later in August 2015, with more pressure to reduce rates amid slowing growth, then RBI Governor Raghuram Rajan had said that interest rate cuts should only be delivered after sustained low inflation, and not as “goodies” doled out after public pleading.
Former RBI governor Duvvuri Subbarao, who was in charge during the global financial crisis and had a five-year tenure from 2008-2013, in his recent book flagged this enduring tension. “Both (Finance Ministers) (P) Chidambaram and Pranab Mukherjee were piqued by the Reserve Bank’s tight interest rate policy on the ground that high interest rates were inhibiting investment and hurting growth,” Subbarao wrote in his book.
In October 2012, then Finance Minister P Chidambaram had indicated that the RBI was not on the same page with the finance ministry. “If (the) government has to walk alone to face the challenge of growth, well we will walk alone,” he said.
In a recent research note, Nomura said most Asian central banks are expected to maintain a gradual hiking pace as Asia’s inflation cycle is benign relative to the US and Europe and there is limited evidence of a wage price spiral.