Playing too safe

The Monetary Policy Committee has missed an opportunity to give the economy — laid low by the drop in velocity of circulation of money — a booster shot. The MPC’s reasons for not cutting repo rates are less than convincing. It cites the “near certainty of monetary policy tightening in the US” and the firming up of crude prices after OPEC’s decision to cut output as the main factors. A rate cut, the MPC implicitly fears, could drag the rupee down below 68 levels against the dollar, spurred by an outflow of FII monies invested in debt towards US bonds. This, the MPC perhaps feels, would further raise fuel costs. It notes that emerging economies are already being rocked by volatility, with India too seeing portfolio outflows amounting to $7.3 billion in October-November. However, the impact of an oil output cut is not expected to be serious. The drop in the annual rupee-dollar forward premiums since July from about 6 per cent to 4 per cent at present suggests that the outlook on the rupee is not a cause for worry. A forex chest of about $360 billion is meant to deal with such contingencies; besides, a depreciation of the currency can help our labour-intensive exports, which are just showing signs of revival. The 10-year G-secs yields too have been on the decline and, at 6.3 per cent, are barely above the overnight repo rate level of 6.25 per cent. A ‘flat yield curve’ is not desirable. But by reacting solely to the external situation, the MPC seems to have overlooked the need to bring domestic business and consumer sentiment, ruffled by demonetisation, back on track. This is despite the fact that it expects 2016-17 growth to fall by 0.5 percentage points, while also conceding that the effects of demonetisation are “unclear”.

Sectors that led Q2 growth — agriculture, construction, hotels, trade, transport and communications —have been worst-hit by the withdrawal of currency. Private consumption too has been impacted. Given the distinctly deflationary environment — retail inflation in November is likely to fall below 4 per cent, and presuming that the currency crisis is here to stay for a few months, this trend may continue — the MPC’s concerns over “core inflation” (excluding food and fuel) seem exaggerated. It seems to have made the age-old monetary policy error of targeting inflation when the lurking fear now is of demand compression (notwithstanding the Seventh Pay Commission outgo, which is restricted to the organised economy) dragging down the economy with it. A rate cut would have boosted ‘animal spirits’, urging the banks to lend their excess liquidity to bonafide businesses.

The RBI should have also been more forthcoming in providing information on the currency situation. We now know that “1,179 crore” of new notes have been printed, but not their value. That ₹11.5-lakh crore of withdrawn currency has returned to the system was all that one could glean from the RBI.

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