Technical considerations have shackled monetary policy: RBI Deputy Governor

There is also an ongoing debate on whether inflation-targeting should be the sole function of the next MPC amid the extraordinary growth shock induced by the Covid pandemic.

Technical considerations under the monetary policy framework have brought the policy to a standstill, Reserve Bank of India (RBI) deputy governor Michael Debabrata Patra wrote in the minutes of the August meeting of the monetary policy committee (MPC). The statement is significant because it comes at a critical juncture, with the term of the first MPC coming to an end. There is also an ongoing debate on whether inflation-targeting should be the sole function of the next MPC amid the extraordinary growth shock induced by the Covid pandemic.

Patra wrote in the minutes, “…monetary policy is forced into a standstill even when there is space available to persevere with its commitment to reinvigorate growth momentum and alleviate the effects of Covid-19.

“In fact, if inflation persists above the upper tolerance band for one more quarter, monetary policy will be constrained by mandate to undertake remedial action, including an immediate and more than proportionate response to head off the build-up of inflation pressures and prevent it from getting generalised.”

He expressed disappointment at inflation surprises in recent months undermining the MPC’s actions and stymieing its resolve to do what it takes to revive growth and mitigate the impact of Covid-19 on the economy. The unanticipated concoction of imputations of the consumer price index (CPI) for April and May 2020, supply disruptions and unrelenting cost push interventions in price formation that have reared up outside the ambit of monetary policy have complicated its conduct, especially as the inflation levitation shows persistence, he said.

RBI governor Shaktikanta Das, too, expressed concern about the impact inflation could have on the future course of monetary policy.

“Although there is headroom for further monetary policy action, at this juncture it is important to keep our arsenal dry and use it judiciously,” Das wrote, adding that one must wait for some more time for the cumulative 250 basis points (bps) reduction in policy rate since February 2019 to seep into the financial system and further reduce interest rates and spreads. “Given the uncertain inflation outlook, we have to remain watchful to see that the momentum in inflation does not get entrenched, which is also dependent on effective supply-side measures. As the economy continues to be in a fragile state, recovery in growth assumes primacy,” Das wrote.

Outgoing external member Chetan Ghate observed that future MPCs should be far more particular about reining in inflation. “…I have been advocating a more cautious path for policy rate reductions since February 2019. However, I have been in a minority in the MPC,” Ghate wrote, pointing to the fact that inflation has now been above the upper band of 6% for months together. He further wrote, “Notwithstanding large rate cuts to spur growth over the last year and a half, growth has steadily declined despite 250 bps in cuts since February 2019. Future MPCs should not go soft on inflation.”

According to Ghate, going forward, monetary and fiscal policy will have to be used wisely with a clear understanding of what can and cannot be achieved in terms of controlling inflation, smoothening out the business cycle, and limiting spurious economic volatility.