Monetary policy and Growth

 Has the monetary policy committee (MPC) of the Reserve Bank of India (RBI) been able to deliver on its objective of keeping frontline inflation of the country under check? Has it been successful in spurring growth while keeping inflation under check? Has it been able to broad-base inflation targeting mechanisms (Given the fact that three members of the MPC are nominated by the Government of India (GoI), who, we may safely assume, would ensure protection of interests of GoI)?

 

Udit Misra of Indian Express attempts to answer some of these questions.

 

 

The first meeting of the MPC in October 2016 delivered a cut in the repo rate by a unanimous decision. It gave hopes of lessened friction between GoI and RBI and both operating in sync. Within a month GoI announced the demonetization of 86% of all currency in a bid to curb black money in the economy. From then on the growth rate of the economy constantly fell due to a series of events: demonetization, the Seventh Pay Commission award (which increased fiscal constraints) and the difficulties in implementation of the Goods and Services Tax (GST). These factors made it difficult to cut rates even though the economic growth started falling.

 

In the October 2017 policy, the MPC stated: “The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates”.

 

Again in April 2018, MPC stated: “(GST) implementation had an adverse, even if transient, effect on urban consumption through loss of output and employment in the labor-intensive unorganized sector”.

 

Even though the country’s economic growth was fast losing steam during 2017 and 2018 the MPC was unable to cut interest rates because there were growing fiscal pressures in the form of farm loan waivers, increasing crude oil prices etc. Between February 2019 and May 2020, though the MPC has cut the repo rate by 250 basis points (or 2.5 percentage points), there was no positive impact on the growth rate.

 

For a body that was supposed to solely target retail inflation and keep it at 4% (+/— 2%), the MPC saw retail inflation staying above the 6% mark on all months since December last year (barring March 2020 when it was lower by a whisker). What is worse, the MPC has no clear understanding of how inflation will pan out. It is not clear whether Covid-19 disruption will be inflationary, disinflationary or, even deflationary.

 

On the growth front, the picture is even worse. India is staring at a historic contraction of GDP. Almost all other factors one can consider are also in very bad shape — and not just because of Covid alone.

 

The question that arises is whether monetary policy is effective at all in spurring economic growth. If a 2.5% reduction in repo rate was unsuccessful in, where is the need tom use it as an instrument of spurring growth? We might be better of limiting repo rate cuts as instruments of inflation management. When the fiscal space is overstretched and when its flexibility is near non-existent, monetary policy action alone seems ineffective in moving up growth.