RBI Sticks To Price Stability, Leaves Growth To Fiscal Policy
The second bi-monthly Monetary Policy of the Reserve Bank of India was announced on June 7, 2017, holding the repo rate unchanged at 6.25 percent. Consequently, the reverse repo rate under the Liquidity Adjustment Facility remains at 6 percent and the Marginal Standing Facility rate and bank rate at 6.5 percent. The Statutory Liquidity Ratio has been lowered by 50 basis points to 20 percent with effect from June 24, 2017. To encourage economic growth, given the importance of housing sector, the RBI has reduced risk-weights of select categories of housing loans and reduced standard asset provisioning rates. This would imply a reduction in the interest rates on housing. The decision to hold the interest rates needs analysis.
Forces At Play: Global And Domestic
Global economic activity has been expanding in recent months, supported by firming growth in advanced countries and some emerging countries.
- Industrial production is improving in the United States and Japan, though the recovery in the Euro area has been impacted by falling employment.
- Among emerging markets, the Chinese economy is stabilising, Brazil is emerging out of recession, Russia is recovering, but South Africa is suffering from structural constraints.
- In commodities, the trajectory of fuel prices, while falling, remains uncertain because of the recent tightening of the market by the Organization of the Petroleum Exporting Countries. Metal and food prices are also declining but bullion prices are rangebound.
- Financial markets are generally resilient to geopolitical events. The U.S. dollar has weakened and the Japanese Yen has strengthened.
Domestically there are economic concerns within the country.
- The growth of real gross value added in 2016-17 is pegged at 6.6 percent with food and horticulture production at a record high.
- Industrial production is also higher than the provisional estimates, mainly on account of the new indices of industrial production.
- The deceleration in services and some segments of industry has been persistent throughout the previous year.
- In the current year, buffer stocks of food are at record high 62 million tonnes, and forecast of a normal and well-distributed monsoon augurs well for food inflation.
- Industrial output in April 2017 in eight core industries has decelerated, which is again a cause for concern.
The domestic economy is vulnerable to global political risks, twin balance sheet problems reflected in an overleveraged corporate sector and stressed banking sector, and inflationary implications of allowances under the Seventh Pay Commission.
The RBI, probably, is following a neutral stance for two genuine reasons. First, past reductions in the repo rate are yet to be reflected in the lending rates of commercial banks so that the transmission is complete before further cuts are introduced. Second, fiscal policy as reflected in recent Union Budget announcements should be able to work through and support investment with improvement in business environment, given structural reforms including the Goods and Services Tax, the Insolvency and Bankruptcy Code and the abolition of the Foreign Investment Promotion Board. In this sense, the coordination between monetary and fiscal policy is exemplary, as both are necessary for macro stability.
Thus, the monetary policy approach of the RBI has been professional and vigilant, with available policy space being utilised for consolidation. However, a few things need to be addressed.
Better Communication
In central banking literature, the importance of communication as an important instrument of monetary policy has evolved over the years, as good and timely communication helps to promote confidence in the policy regime and helps to form and manage expectations – an important task for modern central banks.
Given concerns about the banking sector, the RBI could have shared in today’s monetary policy announcement, the strategy being adopted to resolve the grim situation.
RBI’s communication policy, which was generally matching international standards, has changed in the last few years. Statutory reports have become thinner and crucial data is becoming scarce. In this context, RBI could consider sharing of more research output from its research department as well as that of Centre For Advanced Financial Research And Learning, its fully funded policy research and learning arm. The RBI, given its resources and reach, could also consider dissemination of regional information like the Beige Book of the U.S. Federal Reserve, which shares real-time data with the wider population, enabling the formation of expectations. Policy formulation, dissemination, and transmission would become smoother and seamless with economic agents becoming aware of monetary policy dilemmas.
The standard practice in the advanced countries and those following inflation targeting is to disseminate research and place models in public domain that are being used for forecasting. Since monetary policy takes time to act on output and inflation, sometimes nearly two years, a forward-looking assessment is essential.
In these uncertain times, a forward guidance, even if only a scenario analysis would help in anchoring expectations on interest rates, inflation expectations, banking developments, and financial markets.
Farm Loan Waivers
The issue of farm loan waivers needs to be carefully addressed, as it reflects a complex socio-economic challenge. On one hand, because of various reasons like the slowing of overall growth, increasing automation leading to jobless growth, and implications of demonetisation on many unorganised sectors, the debt carried by farmers has increased and loan waivers seem to be a solution to de-stress the rural economy. On the other hand, the culture of loan waivers is unsustainable in any economy for various reasons. First, it is a commercially unviable model where the borrowed money does not return to the institution for further lending. Second, it breeds irresponsible behavior and encourages unproductive use of borrowed money. Third, it leads to a moral hazard and indirectly punishes an honest borrower who services the loan in a disciplined manner. Finally, empirical literature reveals, globally and in India, that fiscal profligacy of the states or the Centre spills into monetary policy and is not conducive for economic growth.
It is interesting to note that of nearly four dozen changes in the repo rate since 2002, policy rates in June were reduced only once but increased on four occasions. The objective of monetary policy is price stability, given the growth path. The monetary policy of June 2017 has fiercely guarded its objective, given the risks ahead, and left the growth aspect for the fiscal policy to pursue. This implies more coordination between the two components of macroeconomic policy in next few months.
Charan Singh is full time visiting faculty and former RBI Chair Professor at the Indian Institute of Management Bangalore, where he teaches comparative monetary policy and policy issues on the Indian economy.
The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.