Risk of RBI falling behind curve on inflation: member of monetary panel

Consumer price inflation which crossed the RBI’s upper tolerance level of six per cent to 6.01 per cent in January is likely to hit the seven per cent mark as crude prices touched $116 per barrel recently. The RBI had retained its accommodative policy stance and main policy rates in the February policy review.

“I have argued in my successive dissents for many months now that a change in the accommodative stance is long overdue,” said Jayanth Varma, Member of the Monetary Policy Committee (MPC) of the RBI, who has been opposing the RBI’s accommodative policy stance.

“My concern is that the accommodative stance carries with it the risk of falling behind the curve in future because the stance limits the MPC’s freedom of action in ensuing meetings,” Varma, who is a Professor of finance and accounting in IIM Ahmedabad, told The Indian Express.

“My position is not that we should pull the trigger now, but that we should have our hands on the trigger, ready to act if the need arises,” he said.

The RBI’s policy panel set the retail inflation target to average 4.5 per cent in FY2022-23 in the February policy review.

There’s a feeling in some other quarters too that the RBI needs to do more in controlling inflation while retaining the current policy interest rates.

According to Radhika Rao, Senior Economist, DBS, the central bank might cite weak growth prints and need for administration measures to contain the spillover from higher oil/gas onto inflation, backstopping their dovish bias. “Nonetheless, given risks to the price outlook and tighter global financial conditions, we expect them to lay the ground for a gradual exit from their accommodative stance and adjust benchmark rates to pre-pandemic levels in FY23,” she said in a recent report.

The RBI has been putting the emphasis on growth. While unveiling the policy on February 10, RBI Governor Shaktikanta Das said the MPC was of the view that continued policy support – status quo on interest rates — is warranted for a durable and broad-based recovery after taking into consideration the outlook for inflation and growth, in particular the comfort provided by the improving inflation outlook, the uncertainties related to Omicron and global spill-overs.

For the NDA government, the surge intensifies the pressure on the state-owned oil retailers to hike retail prices. These hikes have been put on hold in the wake of the state elections and an increase is expected immediately after the polling is over. A calibration of the hike is now a more complex task, given the cascading inflation impact that could follow in the wake of the anticipated rise in prices.

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Varma also batted for a change in the approach of the central bank while tackling inflation. “Monetary policy makers must proceed with humility, recognise that reality may not unfold according to their expectations, and stand ready to adapt rapidly to the changing conditions. Above all, they should avoid making commitments that restrict their freedom of future action,” Varma said.

“I do not have a crystal ball, and I strongly believe that policy makers should not pretend that they have a crystal ball,” he said.

There’s also a demand for delinking Covid pandemic from the monetary policy as the problems impacting economy have nothing to do with the pandemic. The problem is that the economy has been growing too slowly, at least, since 2019. Investment has been low, private consumption is still lagging behind and the economy is being bolstered primarily by fiscal support. There is an urgent need to push the economy onto the path of self-sustaining growth that would meet the aspirations of our people. “The challenge is that this has to be done in the context of undesirably high inflation. Also, as I argued in my MPC statement, geopolitical tensions are now one of the biggest risks to the global economy,” Varma said.

The Ukraine situation is a threat to both growth and inflation. “While you have emphasised the inflation shock, the growth shock should not be ignored. Some countries in Western Europe might actually tip into recession, and India too could face headwinds particularly (but not only) in terms of exports. We do not know how long lasting and how severe these two shocks would be,” Varma said.

Government sources said the RBI view till recently (before the recent geopolitical developments) has been that since the fiscal policy is in “contraction” mode, the monetary policy must maintain an accommodative stance. The government has pegged the fiscal deficit at 6.4 per cent of GDP in 2022-23, down from 6.9 per cent in 2021-22 and 9.2 per cent in 2020-21.

“From the levels of 9.2 per cent, the fiscal contraction next year will almost be 3 per cent, now this is a huge contraction. At a time when fiscal policy is in contraction, and private consumption is still below previous levels with no likelihood of economy overheating, the monetary policy must remain accommodative under such circumstances. See, it takes the two to tango,” a source said, explaining the central bank’s rationale.

The oil shock would not only lead to spike in inflation, but also a “massive hit on growth”, hitting the recovery process that has begun only recently, they said.

Spiralling oil prices will also impact the budget math as the government has projected oil prices in range of $70-75 per barrel for the next year. “…India’s GDP is projected to grow in real terms by 8.0-8.5 per cent in 2022-23. This projection is based on the assumption that there will be no further debilitating pandemic related economic disruption, monsoon will be normal, withdrawal of global liquidity by major central banks will be broadly orderly, oil prices will be in the range of US$70-$75/bbl, and global supply chain disruptions will steadily ease over the course of the year,” as per the Economic Survey 2021-22.

(With inputs from Sunny Verma and Aanchal Magazine in New Delhi)