Choices in monetary policy
Ever since the Reserve Bank of India moved to an inflation-targeting framework and defined the goal of the monetary policy as keeping inflation around 4 per cent, and within a variation of 2 percentage points in the up or down direction, one thing should have been clear: the inputs on how inflation is moving and is likely to move have become the most critical piece of data to contend with. The more robust the inflation surveys, the more effective would be the policies of the RBI and its Monetary Policy Committee (MPC) in targeting inflation.
What we see today is quite the contrary. At the highest level, there appear to be contrary data points floating around, each offering an inflation trajectory that sits at odds with the other.
The Economic Survey released unconventionally on July 31 sees “now a new phase of relatively low, possibly very low, inflation”, and it begs the question: Is India undergoing a structural shift in the inflationary process toward low inflation? Furthermore, given the target inflation of 4 per cent, the Survey makes a case for the policy repo rate to be 5.25-5.75 per cent as against the present level of 6 per cent.
The Central Statistical Organisation’s CPI (General) data on the other hand reveals that July retail inflation (2.36 per cent) has shown signs of moving upwards but lower than July 2016 primarily due to negative food inflation (minus 0.29 per cent) contributed by vegetables (minus 3.57 per cent) and pulses (minus 24.75 per cent).
Monetary Policy Committee member Ravindra H Dholakia (who voted for a stiff 50-basis points reduction in the policy repo rate at the last meeting of the MPC on August 2) has observed that “my estimates based on our independent exercise suggest” a lower inflation rate at the end of fiscal 2017-18, at around 3.5 per cent, which is 50 basis points lower than the RBI forecast. He has also mentioned that the IIM-Ahmedabad monthly Business Inflation Expectations Survey for May and June 2017 shows that businesses in India expect their cost inflation (core inflation) a year ahead to be around 3 per cent.
Armed with this conviction, Dholakia has argued for steeper cuts in the policy repo rate and an accommodative policy stance rather than the neutral stance that the MPC now has adopted. The meeting ended with a policy repo rate cut of 25 basis points. The introduction of the IIM-A survey is an interesting new addition to data points. It can provide a new perspective that the RBI can weigh in on. After all, the very idea of having a multi-member MPC, with members from outside the RBI, is to enable the veterans of central banking balance their RBI-centric views with what experts (and commoners) outside feel, think and read. To that extent, new surveys are good. But equally they raise questions on the robustness of the surveys and on how these surveys square with the RBI’s surveys, which one presumes are wider, larger and more robust. In this context, the IIM-A survey should be made available and published more widely to enable stakeholders compare its depth with the RBI survey. Equally, the RBI needs to see if its survey is deep enough and if some of its methods and processes need revisiting.
Question of agenda
The worrying aspect should be whether an agenda is being built and a case is being crafted to take the policy, and indeed the entire policy framework, toward aggressive rate reductions by playing on arguments that may not sustain on closer scrutiny. The issue, therefore, is not whether two surveys per se are contrary to each other.
The Economic Survey (Volume II) says that in the last 14 quarters, inflation has been overestimated by more than 100 basis points in six quarters with an average error of 180 basis points (and that too for a very short-term forecast, just three months ahead). The “error”, it is suspected, now puts the RBI under pressure and probably seeks to signal that a conservative approach to the burning question of inflation, which is essentially a tax on the poorest and the weakest of India, is a thing of the past.
Former RBI Governor Duvvuri Subbarao put it well in his book, Who Moved My Interest Rate?: “The government’s pet peeve was that the RBI was being too cynical in its forecasts…almost seamlessly, the discussion would move…to subjective considerations, with one of the senior officers suggesting that the RBI must project a higher growth rate and a lower inflation rate in order to share responsibility with the government for ‘shoring up sentiment’.”
Not having a consensus is welcome but having a hidden agenda will lead to decisions that will not only weaken institutions and the policy framework but also have longer term implications for growth.
Apart from all these, a few issues need to be debated. First is the question on whether metrics like the neutral rate, Taylor rule, potential output, output gap, core inflation should really be a guiding force for taking a decision on monetary policy. These concepts make sense in classroom readings. But compilation of these is subject to data availability and methodological robustness. The degree of capacity utilisation again is an empirical subject.
In this context, what is expected of the MPC is not to showcase different positions and numbers but to debate these, leading to a possible consensus that can reflect a new kind of maturity with professional freedom. To achieve this, agendas must be set aside.
Pattnaik is a professor at SPJIMR, Rattanani is editor. The views are personal (via The Billion Press)
Leading to confusion