Given our inflation outlook has risen quite some distance over the target of 4 per cent, there did not seem much room for monetary policy adjustment

Dr. Viral V. Acharya

Over the past few years, household inflation expectations have been steadily getting anchored down as they are adapting to the realised inflation outcomes, said Dr. Viral V. Acharya at Minutes of the Monetary Policy Committee Meeting October 2017. However, these expectations still remain relatively high, and are likely also manifested in the continuing high level of rural and non-rural wage growth. Recent headline inflation prints have risen significantly from historic low in June and in a broad-based manner; in addition, oil-price risk and global market volatility have risen materially. In such a scenario, it is important in my view for the Reserve Bank to persist steadfastly with its objective (and mandate) of keeping medium-term inflation within a striking distance of the target of 4 per cent.

Real-time activity indicators have been volatile over the last two quarters and do not yet paint a clear picture. Hence, it is too early, in my view, to be able to isolate the transient component of the recent one-quarter loss of momentum over and above the gradual decline in overall growth that has taken place since the Q1 of 2016-17. The gradual decline, which has turned our measures of output gap negative, is best explained by the deleveraging underway in the heavily indebted parts of the corporate sector and in poor credit growth of public sector banks given they have inadequate capital relative to impending losses on legacy assets.

Corporate credit risk profile is showing some signs of improving gradually; the large distressed borrowers are being directed to the Insolvency and Bankruptcy code; and efforts are under way to concretely address public sector bank health in near future. These structural changes will revive the affected economic activity, but with a lag. Teething problems, or at least the uncertainty, facing the Goods and Services Tax (GST) rollout, should also resolve soon. In the meantime, given our inflation outlook has risen quite some distance over the target of 4 per cent, there did not seem much room for monetary policy adjustment.

The Reserve Bank remains committed to improving the transmission of monetary policy. I believe there is still some scope left for transmission of past monetary policy accommodation to existing loan portfolio that is tied to the base rate. Our Study Group on the MCLR has proposed what I find a reasonable path going forward in referencing floating rate loans to simple market benchmarks that will improve transparency for borrowers and competitiveness in lending. I am hopeful that switching to one of the recommended benchmarks with more frequent resets will enhance the effectiveness of monetary policy in future.

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