Normalisation delayed

Monetary policy will not drive growth

The Reserve Bank of India (RBI) has postponed the next step in normalising monetary conditions. In its first meeting after the Union Budget, the RBI’s Monetary Policy Committee (MPC) decided to keep the policy rate and stance unchanged. While this much was on expected lines, the RBI also decided to leave the reverse repo rate untouched. Several commentators, including this newspaper, had advocated normalisation of the policy corridor. It is not clear what restrained the RBI —the reverse repo rate is outside the remit of the MPC. As RBI Governor Shaktikanta Das noted in his statement, the weighted average rate for the fixed rate and variable rate reverse repos was at 3.87 per cent as on February 4. While the RBI has done well to push up the effective reverse repo rate, it could have normalised the policy corridor, at least partially, in a non-disruptive manner on Thursday.

It is likely that the RBI intends to retain the flexibility for some more time, which might help in managing the higher than expected government borrowing. The policy statement and the RBI’s economic projections, in fact, did bring down bond yields. The RBI expects the inflation rate based on the consumer price index to average 5.3 per cent in the current fiscal year and 5.7 per cent in the ongoing quarter. However, it expects the rate to moderate to 4.5 per cent in the next fiscal year. Given the global inflation situation and the level of crude oil prices, it would be interesting to see how consumer prices evolve. As things stand today, domestic fuel prices are likely to see a big jump — possibly after the ongoing Assembly elections — as they are brought in line with international prices by oil-marketing companies. If the government decides to absorb higher prices through tax cuts, it will increase borrowing. Either way, it will complicate matters for the RBI.

Further, the central bank expects the Indian economy to grow 7.8 per cent in the next fiscal year, which is lower than the growth projection of 8-8.5 per cent made in the Economic Survey. However, it is not the full-year number that policymakers and the markets should be focusing on. Growth will be high in the first quarter of the next fiscal year because of a lower base. Economic activity suffered in the first quarter of the current fiscal year due to the second wave of Covid-19. The focus, therefore, should be on the second half of the fiscal year. According to the RBI’s projections, the Indian economy will grow at 4.3 per cent and 4.5 per cent, respectively, in the third and fourth quarter of 2022-23. Growth is likely to be in a similar range even in the second half of the current fiscal year. This should worry policymakers.

As the statistical effect of the Covid-induced contraction wanes, growth is seen to be returning to around the pre-pandemic level, which was not a strong base. Thus, the overall policy objective should be to attain higher sustainable growth. Monetary policy, however, in this context is not expected to drive growth. In the given global and domestic economic environment, excessive monetary policy accommodation for an extended period could end up undermining prospects for higher sustainable growth.