Inflation mandate alone won’t do for MPC

The unanimous decision of the six-member Monetary Policy Committee (MPC) to maintain the status quo on policy rates and a 5:1 majority decision to continue with the accommodative stance did not come as a surprise. But it is a missed opportunity as far as commencing the ‘normalisation’ glide path from the ultra-loose policy rates that have been prevalent since May 2020.

The repo rate, the rate at which the banks borrow from the Reserve Bank of India (RBI), is unchanged at 4 per cent. The reverse repo rate, the rate at which interest is offered by the RBI to banks that park their excess funds with the RBI also remains untouched at 3.35 per cent.

Though the rationale of the MPC to maintain status quo in policy rates is, as spelt out, to support the nascent economic growth -- Q2 (July-September) FY22 GDP of 8.4 per cent, PMI Manufacturing 57.6, GST monthly collections of over Rs 1 lakh crore each month in the last five months, buoyant direct tax collections, fiscal deficit under control, supported by substantial exports of merchandise -- the MPC seems to have underestimated the ‘inflation surge’, which can stifle the very growth and recovery that we are witnessing, overestimating the fear of the Omicron variant of the coronavirus, and has decided to wait and watch the policy measures that will be announced in the Union Budget on February 1. The next RBI/MPC policy announcement is set for February 9.

The mandate of the MPC is to target keeping inflation within the 4 per cent-6 per cent range. Retaining the Consumer Price Index (CPI) for FY22 (April 1, 2021-March 31, 2022) at 5.3 per cent and projecting the Q3 (October-December 2021) at 5.1 per cent and Q4 (January-March 2022) at 5.7 per cent (down from the 5.8 per cent projected earlier) does not make sense.

The increase in food and fuel/oil inflation, rise in global and local commodity prices, loss of commercial crops due to unseasonal rains, and huge input cost pressures will feed into the core inflation which will, in turn, have adverse cascading effects -- leading to show-stoppers to the growth story. The above cues indicate inflation shooting beyond the RBI tolerance level of 6 per cent by March 2022.

The logic of the MPC that the reduction in excise duty and state VAT on petrol and diesel would support consumption demand by increasing the purchasing power of the people is not an economic proposition but an ‘astrological prediction’! A paltry reduction by Rs10-15 in fuel prices, after continuously increasing it by Rs 30-40, is adding insult to injury. Similar is the case with the rise in the prices of edible oil, LPG, auto gas and medicines, which will have a ripple effect on the prices of various other goods and services and thus impact inflation.

High liquidity in the market also poses an inflation threat. Inflation combined with nascent growth but with continuing high unemployment will only lead to stagflation. Nearly Rs 11 lakh crore liquidity is in the market. This was the right time to raise the reverse repo rate by at least 0.3-0.5 per cent to narrow the rate corridor nearer to the repo rate at 4 per cent. This would have also sent the right signals to the banks to lend more aggressively at higher interest rates – rather than park excess liquidity at reverse repo rate -- to productive sectors such as the core industries, MSMEs, infrastructure, real estate and affordable housing. That would have had a multiplier effect on investment, income, employment and savings.

Further, such a move would have also signalled the end of the regime of low-interest rates and applied the brakes on the banks and NBFCs from lending indiscriminately — personal and credit card loans, loans against properties, loans through fintech companies, which can eventually lead to sticky or non-performing assets (NPAs) and brewing of the asset bubble. A hike in reverse repo would have also prevented ‘poaching/swapping of housing loans’ and the ‘rate war’ amongst banks and housing finance companies (HFCs).

Despite surplus liquidity, credit offtake has been dismal and anaemic at 7 per cent. Good AAA-rated corporates are deleveraging their balance sheets by retiring their high-cost loans with low-cost funds through debentures, CPs and other ‘market borrowings’, avoiding banks.

However, RBI is continuing its Variable Reverse Repo Rate operations to absorb Rs 6.5 lakh crore on December 17 and another Rs 7.5 lakh crore on December 31, before moving to the Fixed Reverse Repo auctions from January.

Over the last two years, and especially since the pandemic, the behaviour of the economy indicates changes in the macroeconomic dynamics, where inflation is caused by supply side bottlenecks, huge output gap, input price pressures from global oil prices, geopolitical factors, the emergence of innovative fintech companies and innovative fund-raising methods.

This necessitates a total relook at the very mandate of the MPC, which will have to keep ‘growth’ as the focal point and not merely chase the inflation mandate. Otherwise, the MPC will become redundant.

(The writer is a former banker)

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