In a vibrant democracy, debates over any policy are always wholesome. Confabulations within the government — meaning thereby high-level discussions among various government departments and between the government and a regulatory body such as the Reserve Bank of India (RBI) — were, however, not only confidential, but sometimes even beyond the purview of the Right to Information Act. Things seem to have changed with the debate over inflation and monetary policy. There is a remarkable degree of openness in the exchange between North Block and Mint Street.
In the face of vigorous demands for policy relaxation, the Monetary Policy Committee (MPC), after its meeting on June 21, had recommended a neutral stance, and the RBI kept the repo rate, at which it lends to banks against securities, unchanged at 6.25 per cent. The Consumer Price Index (CPI) inflation of 1.54 per cent for June 2017, released recently, has led to renewed calls for a reduction of rates by the RBI.
Newspaper reports of North Block’s demand that policymakers “reflect” after CPI inflation at a record low in June amid faltering industrial growth is a not-so-veiled reference to the shenanigans in Mint Street. Fortunately, Mint Street is still silent. Perhaps it believes that discussions among policymakers on technical matters such as monetary policy should be done in committees and expert bodies, and not in the Ramlila Maidan. While North Block and Mint Street settle their differences, what follows is a private citizen’s public reflection on the appropriate monetary policy stance after the low inflation in June 2017.
First, has the RBI failed to achieve its inflation target of 4 ± 2 per cent? From 6.0 per cent in July 2016, the CPI rate, after declining every month except in February and March 2017, reached 1.54 per cent in June 2017. From August 5, 2016, with a Government notification, the RBI has a statutory and institutional inflation-targeting framework. The CPI inflation target is 4 per cent with upper and lower tolerance limits of 6 per cent and 2 per cent, respectively. The Monetary Policy Committee (MPC), with its five members and RBI governor as chairman, provides the RBI with an institutional framework for determining its policy.
The government was fully aware of the fact that inflation could over-or under-shoot the target of 4 ± 2 per cent for transitory reasons. Thus, it specified that the RBI would be considered to have failed in inflation targeting only when inflation is beyond the upper or lower tolerance levels, not for a single month or even a single quarter, but for any three consecutive quarters. Thus, in spite of the CPI inflation of 1.54 per cent in June, it is a bit premature to declare that the RBI has failed in its targeting endeavour.
Second, is the MPC off the mark in its inflation projection of 2.0-3.5 per cent during the first half of 2017-18? In the first quarter of the current year, CPI inflation was 2.24 per cent. Even with the 1.54 per cent rate in June, the MPC could still be proved right in its projection. For example, if the CPI goes up by just 1 per cent in July 2017 over the previous month and remains unchanged until September 2017, CPI inflation over the same month of the previous year will remain below 2 per cent in each of the three months of the second quarter. Yet, average CPI inflation for the first half of 2017-18 will be above 2 per cent. Thus, it is a bit premature to fail the MPC on the ‘accuracy of projection’ test.
Illustration by Ajay Mohanty
Third, the decline in the consumer food price index (CFPI) of 2.12 per cent played a major part in keeping the CPI at 1.54 per cent in June. Food items have a weight of almost 50 per cent in the CPI. Inflation in June was well over 4 per cent for clothing and footwear, housing and fuel and light. Furthermore, the food price decline has been particularly steep for vegetables (-16.53 per cent) and pulses and products (-21.92 per cent). With the Food and Agricultural Organisation’s (FAO’s) food price index rising for two months in a row during May and June 2017, the decline in the CPI inflation rate in India carries a risk of reversal.
Fourth, is the RBI taking too restrictive a policy stance and hurting the economy? Gross domestic investment, which was 42.5 per cent of gross domestic product (GDP) in 2012-13, has been languishing at 38-39 per cent of GDP during 2013-14 to 2015-16. Indeed, there is a need to raise domestic investment, but the binding constraints on such investment may not be too high rates of interest but infrastructural deficiencies, governance deficit, and regulatory issues impinging on ease of doing business. It is instructive to remember the aphorism that sometimes monetary policy is like a string, you can pull on it, but not push.
Last, but not the least, is the question of inflation expectations. Inflationary expectations, by affecting both demand and supply, can be self-fulfilling. Some policymakers may see the imminent death of inflation the Goliath. But, because of entrenched inflationary expectations, many see inflation in India more like the demon Raktabij of Markendaya Purana. Clones, equally formidable, spring from drops of his blood.
The May 2017 round of the RBI’s Inflation Expectations Survey of Households showed that only 27.3 per cent of the respondents believed that inflation would be negative, nil, or even less than the then prevalent rate. The average expected inflation three months and one-year ahead was both well above the RBI’s target of 4 per cent. The enemy may have been weakened, but may be far from dead. A premature declaration of victory runs the risk of a deadly counterattack. It has happened before. After wholesale price deflation in 1968-69 and 1975-76, inflation soon returned with all its fury.
The writer is an economist