Indian Monetary Policy: Keeping Best of Two Worlds!

In its recent Monetary Policy the Reserve Bank of India seems to have shifted its bias from growth back to keeping inflation within the tolerable limits. In the last two years the central bank has adopted accommodative monetary policy stance in tandem with the large scale economic stimulus and policy reforms introduced by the central government and this complimentary effort even bore fruits as the Indian Economy bounced back from its decelerating growth rate during the pandemic affected phase to the recovery mode beating even the pre-pandemic levels in the current year.

On one hand the RBI resolved to keep the policy repo rate (LAF) unchanged at 4.0 per cent and also the marginal standing facility (MSF) rate and the Bank Rate both unchanged at 4.25 per cent, but, on the other hand it raised the standing deposit facility (SDF) rate to 3.75 per cent. The monetary policy claims to remain accommodative yet it gives a hint that there is a change in its focus indicating the start of the process of withdrawal of accommodation to ensure that inflation remains within the target while still supporting growth. Clearly, the RBI wants to keep the best of its twin objectives: one – supporting growth in a pandemic hit Indian economy and two – keeping inflation within the target range of plus-minus 2% on either side of 4%.

Challenges posed by the Global Economy

The last policy instance was declared in February 2022, The RBI observes that the global economic and financial environment has only worsened since then. The major causes are:

• Rising geopolitical conflict and accompanying sanctions imposed on the concerned attacking nation resulting into an escalation in the commodity prices which translated into increased burden on the Balance of Payments of the countries which are net importers of commodities.

• Crude oil prices reached a 14-year high in early March and showed extreme volatility at elevated levels.

• Increasing pressure on the supply chains.

• Rise in inflationary pressures across most economies caused a sharp revision in their inflation projections.

• The global composite purchasing managers’ index (PMI) also decelerated to 52.7 in March from 53.5 in February indicative of weak output growth in both manufacturing and services sectors.

These factors led to the weakening of momentum in the merchandise trade globally. Further the financial markets also felt the heat and showed volatility in many countries, including the ones that had shown resilience in the recent past. India was no exception to these adverse forces present and impacting the global economy.

Mixed trends seen in the Indian Economy

India’s real gross domestic product (GDP) growth rate is projected at 8.9 per cent which is even 1.8 per cent higher than the financial year 2019-20 level signifying that the economy has bounced back. This is corroborated by higher growth rate achieved by the major constituents of the real gross value added (GVA) including services compared to the pre-pandemic levels. But the point is that major  growth indicators in some sectors are giving mixed signals.

On one hand, there is an increase in urban demand as reflected by the rising demand for air travel and vehicle sales, but on the other hand, the rural demand may have contracted as reflected by decrease in demand for two-wheeler and tractor sales in the month of February. Similarly, there was good amount of increase in import of capital goods in the month of February, even as the domestic production continued to contract. Hence, although the merchandise exports achieved smart double-digit growth for the thirteenth successive month in March 2022 the imports but increased at a faster pace for almost all commodities categories creating pressures on India’s merchandise trade balance.

On one hand, the food grains production touched a new record in 2021-22 yet the manufacturing PMI moderated a little to 54.0 in the month of March from 54.9 in February. But then the services sector PMI increased to 53.6 in March from 51.8 in the preceding month.

Under these mixed trends the headline CPI inflation breached the upper tolerance threshold of 6 per cent as it reached at 6.1 per cent in February. It is ironical to note that even as the food grains production reached at the record levels, the increase in food inflation was the major contributor to the rise in headline inflation.  Surprisingly again, the fuel inflation and the core inflation showed the signs oof moderation.

However, the overall system liquidity remained in large surplus and India’s foreign exchange reserves increased by US$ 30.3 billion to US$ 607.3 billion in 2021-22.

Striking balance between growth and keeping inflation under control – A tough task

The inflation rate in the next period may be contingent upon whether the geopolitical situation improves or worsens as it may continue to affect the global commodity prices and logistics. For example, domestic prices of food items increased in tandem with the rising international prices. Increased volatility in International crude oil prices coupled with massive uncertainties about the smooth functioning of the global supply chains have all caused an escalation in prices of key industrial inputs.

The worse is that the current scenario of rising disruptions in the global supply chain and increase in input costs may continue to haunt the global economy as the geopolitical tensions seem to be taking longer time to resolve than expected as they become more complex every next day. The wars become more complex when they are fought not only for attacking or defending a territory but also to satisfy the two ego states of minds thronged by competing or rather conflicting ideologies.

Hence, there is absolutely a grave need to balance the persistent pressures on the inflationary front while at the same time giving support to keeping up pace of growth in the Indian economy under highly challenged circumstances.

In the light of the risks and uncertainties surrounding the global economy, the Monetary Policy Committee of the Reserve Bank of India has decided to keep the policy repo rate unchanged at 4 per cent quite in line with its accommodative instance for supporting growth in the Indian economy.

Yet the RBI has given clear indication of its willingness to withdraw monetary accommodation in order to fulfil its primary commitment to keep inflation within the target range. For instance it decided to restore the width of the Liquidity Adjustment Facility (LAF) corridor to 50 basis points back to 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.