Ball in Centre’s court

In his interview to this newspaper published on Wednesday, Reserve Bank of India Governor Shaktikanta Das makes some significant observations on the growth-inflation trade-off and the multiple considerations weighing on its policy actions that render its job a tight-rope walk. His views come amidst a debate on whether retail inflation, at 5.6 per cent in July against 6.3 per cent in May and 6.26 per cent in June, needs to be taken more seriously. Das leans towards growth, observing that the “process of economic revival is delicately poised”. Interestingly, in arguing for growth over inflation, the Governor cites the Reserve Bank of India Act, rather than the more recent flexible inflation targeting policy. He rightly advocates gradualism saying that changing course from one-and-a-half years of policy “has to be very, very carefully done”. The view seems to be that the Monetary Policy Committee has done whatever it can to spur growth, by reducing the repo rate by 115 basis points since March 2020 to 4 per cent. The RBI has deployed several unconventional tools, from the TLTRO to ECLGS, to reach targeted credit to the more stressed sectors of the economy. Aggregate bank credit growth however remaining at 6 per cent suggests that the RBI can take the horse to water, but cannot make it drink. Bankers remain risk-averse, parking large sums in the reverse repo window, while India Inc remains in deleveraging mode.

On inflation, the RBI is right to take the indirect path to moderating liquidity through Variable Rate Reverse Repo auctions and other measures, without overtly changing the tone of its policy and causing disruptions. As suggested by some MPC members, it can still raise the reverse repo rate to mop up liquidity at the short end of the bond market but remain ‘liquidity surplus’. Indeed, ‘normalisation’ and liquidity surplus positions can co-exist, as explained by the Governor in his interview. Such nuanced steps would make an eventual exit from accommodation simpler.

However, there are limits to boosting credit through low rates or targeted credit, in a demand-constrained economy. When the RBI holds rates low for extended periods, savers are hurt through negative real rates. In a situation of cost-push inflation, raising rates will ramp up costs of production. India could get a flood of inflows, raising the exchange rate and hurting exports. Allowing the exchange rate to appreciate at current interest rate levels to head off imported inflation is a possible route. But the Centre and the RBI seem to be clear that this is not a risk worth taking, given the nascent revival of exports and the jobs that ride on it. That is the right call in the prevailing situation. Overall, the ball now seems to lie squarely in the Government’s court both on reviving demand and curbing inflation through supply-side measures. While the RBI manages liquidity to curb prices, fiscal policy can curb tariffs and taxes (both direct and indirect) to boost consumption and lower inflation, besides boosting efficient spending.

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