Amid notes of dissent from rate panel, RBI must keep an eye on markets
Premium- The minutes of the August meeting that were released last week reveal that inflation has become a major worry for most members
“Monetary accommodation appears to be stimulating asset price inflation to a greater extent than it is mitigating the distress in the economy." That is a straight arrow warning given by one of the external members of the Reserve Bank of India (RBI) monetary policy committee (MPC).
The warning should not only make India’s central bank reconsider its “whatever it takes" policy stance but global central banks too should take a hard look at their approaches. Central banks across geographies have pumped in an unprecedented amount of liquidity into markets ever since covid began spreading in early 2020. The US Federal Reserve has been buying billions worth of bonds every month, and keeping its policy rate near zero. Perhaps for the first time, the Fed has decided to look away from its 2% inflation target. Global markets have been on a high, riding on the liquidity provided by their central banks.
India is not an exception with the bellwether Nifty having soared more than 100% from its low hit in March last year. Government bond yields have hardly budged even as the Centre’s borrowing hit an all-time high simply because the RBI is the biggest buyer in town. This even as the economic recovery has been sluggish, inflation has risen, and the pandemic continues to rage on.
Asset prices divorced from economic reality are a threat to financial stability, something that the RBI is aware of.
Jayanth Varma, who sounded the warning, believes that the time has come to begin unwinding accommodation. In fact, the RBI would have raised its reverse repo rate in August, if Varma had found support from other members. Varma argues that short-term rates need not be low given that signs of asset price inflation are becoming stark. Monetary policy has a broad-based effect on the economy and therefore would be an inefficient solution when the distress from the pandemic is uneven and restricted to certain pockets of the economy. Further, inflationary expectations are becoming entrenched, Varma warns.
What do other members believe? The minutes of the August meeting that were released last week reveal that inflation has become a major worry for most members. In fact, Varma finds support in his concern from Mridul Saggar, member of the RBI on this. Saggar points out that the persistence in inflation is worrisome. Michael Patra, deputy governor in charge of monetary policy too doesn’t brush off inflation as entirely supply-driven. That said, the biggest difference between Varma and the other two members is the assessment of demand. Both Saggar and Patra believe that given the slack in the economy, disinflationary pressures cannot be ignored and that demand-driven inflation is still far from worrisome. Governor Shaktikanta Das too belongs to this camp.
It is clear that vexing inflation is dividing the assessment within the MPC. Whether Varma sees his concerns over financial stability manifest or whether the RBI members are proven right on their weak demand hypothesis hinges completely on the nature of inflation from here on. Analysts at Barclays Securities (India) Pvt Ltd believe that the minutes highlight the increasing caution on price pressures but in no way indicate an early unwinding.
Growth remains the RBI’s focus, analysts say. But the central bank needs to keep in mind how its liquidity is contributing to a frothy market.
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