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The Monetary Policy Committee (MPC) of the Reserve Bank of India did not make any change to the two most important monetary policy tools in its April meeting — the policy rate remains unchanged at 4% and monetary policy stance continues to be accommodative — but made it clear that monetary policy focus, going forward, will start pivoting towards controlling inflation rather than throwing the kitchen sink at the Indian economy’s growth problem.
The latter has been MPC’s stated strategy since the pandemic hit, and the shift in policy focus is not because it does not see the growth challenge as critical. In fact, growth prospects of the economy are expected to worsen going forward. It is the upside risks to inflation, thanks to the ongoing geopolitical crisis, which has forced a change in MPC’s stance.
Inflation and growth forecasts given in the MPC resolution published on April 8 underline the recalibration in policy. Benchmark inflation growth, as measured by the Consumer Price Index (CPI), is expected to be 5.7% in 2022-23, a sharp increase from the 4.5% forecast in the February meeting (it took place before the Russian invasion of Ukraine). GDP growth for 2022-23 is now expected to be 7.2%, a downward revision from the 7.8% projection in the February meeting.
The MPC resolution clearly spells out the change in policy priorities. While the February 2022 resolution talked about continuing with “accommodative stance (of monetary policy) as long as necessary to revive and sustain growth on a durable basis”, the latest resolution talks about remaining “accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”.
That’s a change in priorities since the onset of the pandemic. “The extraordinary liquidity measures undertaken in the wake of the pandemic, combined with the liquidity injected through various other operations of RBI have left a liquidity overhang of the order of ₹8.5 trillion, “RBI Governor Shaktikanta Das said. This will be withdrawn over several years in a “non-disruptive manner beginning this year,” he added. In the course of his comments after the policy, Das mentioned that apart from crude oil, prices o wheat, edible oil, poultry, animal feed, and some metals have all become volatile on account of the Russian invasion of Ukraine.
MPC also expects the average price of India’s crude oil basket to be $100 per barrel in 2022-23, which suggests that it has taken a different view from the finance ministry . “The impact (of high crude prices) will depend not only on the level of oil price but also on its persistence. We must remember that the new financial year hasn’t yet started. It is possible that oil prices will settle down in a range that is tolerable for us,” Chief Economic Advisor (CEA) V Anantha Nageswaran told Bloomberg Quint in an interview on March 30. This year’s Economic Survey – the current CEA was not in office when it was presented – assumed an average crude price in the range of $70-75 a barrel.
“This (oil at $100 per barrel) would be a $30 per barrel increase from the $70/barrel witnessed in 2021 and would constitute a large, negative terms of trade shock to the tune of 1.2% of GDP for India. Put simply, the economy would be transferring out an incremental 1.2% of GDP for the same net oil imports (crude imports adjusted for petroleum product exports)”, Sajjid Z. Chinoy, J.P. Morgan’s Chief India Economist said in a note dated March 5, 2022, highlighting the additional headwinds high oil prices will bring for the economy apart from inflation.
To be sure, RBI has gone beyond mere words to begin a withdrawal of what has been an extra ordinary long spell of easy money phase in the Indian economy. “It has been decided by the Reserve Bank to restore the width of the Liquidity Adjustment Facility (LAF) corridor to 50 basis points, the position that prevailed before the pandemic. The floor of the corridor will now be provided by the newly instituted standing deposit facility (SDF), which will be placed 25 basis points below the repo rate, i.e., at 3.75 per cent”, Das said in his statement, announcing a move which could expedite the withdrawal of excess liquidity from the economy. The change was not expected. “For the last three years starting February 2019, we put growth ahead of inflation in the sequence,” Das told reporters.
Experts agreed on the expectation of future normalisation of monetary policy. “Sharp upward revision in inflation forecast has prompted them (RBI MPC) to revert to giving inflation primacy over growth”, Samiran Chakraborty, Chief Economist, India at Citi Research said in a note. “We have brought forward our views on stance change to Neutral (in June) and the first repo rate hike (in August) but incoming growth/inflation trends will determine the pace of adjustment”, the note added.
RBI’s comments also suggest that the onus of managing growth is now largely with the government — with the central bank beginning to manage inflation.
“We noted recently that India has two policy objectives (safeguarding growth and controlling inflation) and two instruments (fiscal policy and monetary policy). An appropriate strategy, whereby fiscal policy set by the government focuses on growth and monetary policy set by the RBI focuses on inflation, could achieve an optimal outcome”, HSBC India Chief Economist Pranjul Bhandari said in a research note.
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