The Monetary Policy Committee (MPC) risks a damage to its credibility when it uses words that do not accurately reflect what it means, cautioned Jayanth R Varma, Member-External, MPC, and Professor, Indian Institute of Management, Ahmedabad.
While voting in favour of the Resolution to keep the policy repo rate unchanged at 4 per cent, along with other five members of MPC, Varma was the only Member who voted against the formulation of the Resolution.
As per the Minutes of the MPC meeting (October 7-9), Varma disagreed with the MPC’s formulation: “The MPC also decided to continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
The Professor emphasised that his formulation of the forward guidance would have been: “The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward."
“The MPC expects to maintain a low policy rate and an accommodative stance during the current financial year and well into the next financial year.”
The MPC Member observed that his formulation differs from the actual MPC resolution in two respects.
“First, in my formulation, the date based forward guidance is not a decision but an expectation. In a world that is full of unpleasant surprises, the MPC must of necessity be data driven.
“Covid-19 was an example of a totally unanticipated growth shock that came out of nowhere. If a similarly unforeseeable inflation shock were to hit the economy, I find it hard to believe that the MPC will remain accommodative.”
Disgreement with “decided”
In practice, he suspects that the word “decided” only means an intention to remain accommodative as long as realized outcomes do not diverge drastically from what is currently expected.
“I am firmly of the view that the MPC risks a damage to its credibility when it uses words that do not accurately reflect what it means."
“I therefore disagree with the choice of the word “decided” when it comes to the date based forward guidance in the MPC resolution,” Varma said.
To have the desired impact, the Professor felt that it is desirable that the forward guidance extend beyond the one year horizon at which the steepness of the yield curve sets in.
“Forward guidance of six months in the MPC resolution is in my view suboptimal. I would also point out that the weakness of investments in the Indian economy predates the Covid-19 pandemic, and this merits a longer term response that goes beyond six months,” he added.
Das speak
RBI Governor Shaktikanta Das underscored that MPC should strengthen its forward guidance by indicating that the accommodative stance would continue as long as necessary - at least during the current financial year and into the next financial year - to revive growth on a durable basis and mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward.
“Monetary policy at this stage has to provide adequate support to ensure a robust revival of the economy from the devastating effects of COVID-19, while at the same time ensuring that any persistence of elevated inflation does not lead to unanchoring of inflation expectations,” Das said.
Technical recession
MD Patra, Deputy Governor, RBI, warned that if the NSO’s provisional estimates for Q2 (July-September) that are expected at the end of November corroborate at least the direction of MPC’s forecasts, India has entered a technical recession in the first half of the year for the first time in its history.
Nonetheless, if the projections hold, the level of GDP would have fallen approximately 6 per cent below its pre-COVID level by the end of 2020-21 and it may take years to regain this lost output, he said.
“In the current milieu, however, both monetary policy and fiscal policy in India face tightening constraints, some idiosyncratic.
“For fiscal policy, it is the collapse of tax revenue – by 32 per cent in the first quarter…For monetary policy, it is the persistence of headline inflation above 6 per cent for the third month in succession,” Patra said.
The Deputy Governor observed that structural reforms to unlock growth impulses are needed, but may lack social traction in an atmosphere of depressed growth and employment, and high uncertainty.
Mridul K Saggar, Executive Director, RBI said the latest projections reaffirm that inflation will fall in line with the target, while growth has plummeted, thus decidedly shifting the growth-inflation policy trade-off in favour of supporting growth within the flexible inflation targeting paradigm.
Shashanka Bhide, Senior Advisor, National Council of Applied Economic Research, Delhi, felt that the outlook for growth and inflation for the next 3-4 quarters suggests the need for a policy environment enabling recovery of output. The inflationary pressures are a concern but present assessment reflects moderating inflationary pressures in the remaining quarters of the year, he added.
Ashima Goyal, Professor, Indira Gandhi Institute of Development Research, Mumbai, said: “Mitigating the impact of the unprecedented global health crisis has priority. It is important, however, there is neither over-reaction nor untimely reversal.
“Policy should aim for balance and use available space when it would be most effective.”
Inflation is at present above the target band although it is expected to come down, Goyal said, adding therefore, no change in the policy rate itself is appropriate while awaiting the impacts of on-going supply-side improvement, as well as for uncertainty around COVID-19 to dissipate.