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Thursday, September 23, 2021

If inflation remains elevated, Monetary Policy Committee could lose credibility. This must be avoided

If inflation continues to stay elevated, the MPC risks losing credibility vis-a-vis achieving its objective of price stability, which could lead to the unanchoring of inflationary expectations. This must be avoided.

By: Editorial |
Updated: September 11, 2021 9:39:36 am
Das also sought to burnish the RBI’s inflation fighting credentials.

Recently released GDP data suggests that the economic fallout of the second wave of the pandemic, amid the localised restrictions imposed to curb its spread, was less severe than last year. In the first quarter of the current year, the economy was about 9 per cent lower than its pre-Covid levels. In the period thereafter, high frequency data indicates that parts of the economy are near their pre-Covid levels, though the contact intensive services sectors continue to lag. On Thursday, Shaktikanta Das, governor of the RBI, expressed optimism over the state of the economy. Speaking at an event organised by The Indian Express and the Financial Times, Das noted that the economy will witness a sequential improvement in the second quarter, as “fast-moving indicators are looking quite upbeat.” However, not only will the second quarter numbers also be distorted owing to the base-effect — the economy had contracted by 7.4 per cent in the same period last year — there is also considerable uncertainty over the momentum of the recovery. The Nomura India Business Resumption Index fell to 100.6 in the week ending September 5 from 102.8 the week before. Equally uncertain is the extent to which the distress in the informal economy has receded.

Das also sought to burnish the RBI’s inflation fighting credentials. “The RBI is an inflation targeting organisation”, and is “very serious about anchoring inflation expectations and inflation around the target”, he said. These comments come in the midst of growing concerns over the continuing accommodative policy stance of the central bank in light of retail inflation continuing to stay elevated. Das defended the stance, pointing out that the MPC was taking advantage of a flexible inflation targeting regime: “Instead of the exact target of 4 per cent, the MPC has decided to operate within the band of 2-6 per cent”. Worryingly, however, inflation, contrary to expectations of being transitory, has remained dangerously close to the upper limit of the inflation targeting framework. And though the RBI expects it to moderate, inflationary pressures are showing persistence, and may well turn out to be sticky on the downside.

On the pivot towards policy normalisation, Das has argued that the RBI/MPC which are “very closely watchful of inflation”, are also “watchful of the growth impulses becoming sustained and taking deeper root”. These comments suggest that the RBI is unlikely to withdraw the accommodative measures in a hurry, unless it sees a durable recovery taking shape. However, it needs to be mindful of the costs of ignoring inflation. If inflation continues to stay elevated, the MPC risks losing credibility vis-a-vis achieving its objective of price stability, which could lead to the unanchoring of inflationary expectations. This must be avoided, if space is to be created for the MPC to navigate this tumultuous period.

This editorial first appeared in the print edition on September 11, 2021 under the title ‘The inflation risk’.

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