RBI’s lost the plot on monetary policy
towards ₹8 lakh-crore.
Patel got a lot of criticism for the thing he was not responsible for: Demonetisation. It was a political decision, an executive decision, and those who disliked the NDA government for various reasons wanted Patel to exercise his independence and either criticise the government or manage the process of remonetisation unilaterally. This would have been the wrong thing to do, and Patel took the flak stoically and refused to be a dissonant voice that could have damaged confidence in the economy further. Despite the RBI’s small missteps in the November-December period, this was actually Patel’s finest hour, as the central bank managed the whole process of normalisation in four months.
But the allegation that Patel was some kind of government lackey probably got to him, and that is when he veered off in directions that have not been helpful to the economy or his reputation. In particular, the MPC’s decision in February to shift monetary policy from “accommodative” to “neutral” needlessly circumscribed the RBI’s freedom to act fast to cut rates if inflation showed signs of significant easing. Having prematurely shifted the monetary stance, the next two policies in April and June were delusional. Even as both retail and wholesale inflation were crashing, the RBI sat tight, with the chief economic adviser famously excoriating the central bank for its large “forecast errors” that were “systematically one-sided in overstating inflation”.
Let’s be clear. The problem we now face, post the economic shocks of demonetisation, the good harvest, the decision to force banks to take large losses by pushing big corporate defaulters into liquidation, and the slowdown precipitated by the shift to GST (which will blight sales in two quarters, April-June and the current one) is not inflation. It is disinflation and possible deflation (a situation where prices start falling in absolute terms).
Given a choice, in a poor country like India it is always better to risk inflation and opt for growth than risk deflation, which will destroy jobs and growth. The RBI needs to course-correct, and the August policy needed to see a sharp cut in rates by at least 50 basis points (that is, one half of one per cent). But the MPC and Patel have flunked the test by cutting rates by a niggardly 25 basis points.
It’s a pity that the governor is fighting the last war (inflation), when the next one — slowing growth — is upon us.