RBI simply doesn’t get it PDF Print E-mail
Monday, 23 October 2017 05:07
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That an MPC member is talking of a rate-hike says it all

It is not clear if, in December, the central bank will actually raise the repo rate as one member of the Monetary Policy Committee (MPC) has suggested RBI be prepared “to quell the underlying drivers of inflation if they strengthen further”, but it has to be worrying if two members of the MPC feel the role of monetary policy is limited. Michael Patra, just quoted, talks of the need to reinvigorate the manufacturing slowdown but, given this “persists in spite of a reduction of 200 basis points in the policy rate”, he asks whether this is “within the narrow remit of monetary policy?”. He then rubbishes the idea of lowering the hurdle rate to a level at which investment becomes viable, quite oblivious of the fact that real interest rates in India are at a multi-year high. Chetan Ghate, another member, talks of research done by him and some colleagues on what explains the change in output over the last five years and concludes “monetary policy shocks only explain around 12 per cent of output variations”. While the MPC members could be right about not everyone rushing to invest if the real rate of interest comes down, surely they must realise this will help improve every firm’s balance-sheets, and hence capacity to invest? And, to the extent the fall in investment growth is due to a decline in household investment in dwellings, the impact of a rate-cut on stimulating demand cannot be overstated.

While Ghate, Pami Dua and RBI Governor Urjit Patel talk of the danger to inflation due to a likely slippage in the fiscal deficit, they ignore the fact that this principle cannot apply in a low-demand situation as today—the RBI view is that a 100bps hike in the combined deficit raises CPI by 50bps. While this held between 2005 and 2010—the combined deficit rose from 7.3% to 9% and inflation rose from 4.2% to 10.5%—in the last five years, when the combined deficit was high, but fell slightly from 6.8% in 2013 to a likely 6.3% in 2017, CPI collapsed from 9.4% to 3.7%; between 1998 and 2004, the deficit fell a bit from 9.5% to 8.8% and CPI crashed from 13.3% to 3.9%. In other words, the correlation, and causality, is not definitive. And while RBI fears a hike in inflation given “the favourable base effect tapered off in July and disappeared in August”, it is worth keeping in mind that September inflation was the same 3.3% as in August—and, if Ravindra Dholakia is to be believed, if the housing index which has been temporarily hiked due to the pay commission award is to be taken out, the current inflation level is just around 3%.


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