A reality check for India’s monetary policy

| Updated on April 12, 2020

The Covid outbreak seems to have prompted the MPC to revise its sanguine view of the economy

After taking an inexplicably sanguine view of a stalling economy and rising inflation in its reviews until February 2020, India’s Monetary Policy Committee has taken cues from the Covid-19 outbreak to drastically revise its opinion. The monetary policy report released by the RBI last week reflects the substantial change in the Committee’s stance since it delivered the off-cycle rate cut of 75 basis points on March 27.

On growth, the report admits that India’s actual GDP growth rates at 5.1 per cent in Q2 FY20 and 4.7 per cent in Q3 FY20 substantially undershot the committee’s projections of 5.3 per cent and 6.1 per cent respectively, with ‘unanticipated downward surprises’ springing up from weak private consumption and the collapse in fixed capital formation. Going forward, it sees risks to GDP growth tilted to the downside. Private consumption, it believes, is now at serious risk from Covid-19, external demand is clouded by the prospect of global recession, and domestic output is hit by the lockdown. The Committee has been equally off the mark with its inflation projections too. Having pegged consumer price inflation rates at 3.5 per cent for Q3 FY20 and 3.7 per cent for Q4 FY20, the committee found actual rates overshooting at 5.8 per cent and 7.1 per cent respectively. It attributes this to unseasonal rains that disrupted the kharif crop, the spike in onion prices and cost-push factors such as higher mobile tariffs. Looking ahead, it expects weak demand and the crude oil collapse to moderate CPI inflation, but also hedges this bet by warning that forecasts are ‘hazardous’ today as the depth, spread and duration of Covid-19 can dramatically alter the situation.

While it is good to see the MPC re-align its forecasts to ground realities, the slip-ups highlighted in the report do call for introspection. To arrive at its assessment of prospects for the economy, the MPC appears to rely rather heavily on the RBI’s forward-looking surveys of households on inflation expectations, industries on output and professional forecasters on growth. But such surveys seem to capture prevailing sentiment far more than fundamentals, and are subject to change at short notice. For instance, the report mentions that when the RBI conducted its routine survey of industries in January-March 2020, participants expressed optimism about output, order books and employment, but they had swung to pessimism on all these counts when a quick survey was conducted on March 18-20 after the Covid outbreak. Given that market participants and professional forecasters are prone to both bias and error, the MPC’s forecasts would be more confidence-inspiring if they relied more on the RBI’s in-house analytics. Then there is the fact that the report focusses extensively on analyses of past data, while most readers today are looking for scenario-building on the future. Presenting high-quality, forward-looking analyses to back up its rate decisions would not just bolster the MPC’s credibility but also help it remain ahead of the curve in fulfilling its monetary policy mandate.

Published on April 12, 2020

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