SCOPE TO EASE MONETARY POLICY

MONETARY POLICY COMMITTEE SHOULD TARGET INFLATION BETTER

There is a “considerable” case for monetary policy easing by the six-member Monetary Policy Committee (MPC) given that retail inflation is at historical lows and there is a wide divergence between headline numbers and inflation targets, Volume II of the Economic Survey 2016-17 said.

The Survey, drafted by Chief Economic Advisor Arvind Subramanian and his economic division in the finance ministry, also criticised the Reserve Bank of India’s (RBI’s) inflation modelling. It said that in the past 14 quarters, inflation had been over-estimated by more than a 100 basis points (bps) in six quarters, with an average error of 180 bps.

“The conclusion is inescapable that the scope for monetary easing is considerable, more than that suggested by comparison with neutral interest rates,” the Survey said.

Subramanian’s criticism in the Survey of the MPC’s monetary policy stance was diluted compared to past instances. As reported in Business Standard earlier, the tabling of the Survey had been considerably delayed as some sections in the topmost rung of government had objected to Subramanian’s strong criticism of the six-member MPC’s inflation modelling and monetary policy decisions. It is understood the document released on Friday had some changes compared to an earlier draft.

In the Survey, Subramanian said since the inflation targeting-cum-MPC framework was new, it was imperative for the set-up to establish credibility. “So, it is important that inflation be kept close to its target level,” the document said.

“Even if inflation reaches four per cent by end-March 2018, the average inflation for 2017-18 will likely be around three per cent. The resulting average real policy rate would then be substantially greater than suggested by the target inflation rate,” the Survey said. The MPC is bound to a medium-term headline Consumer Price Indexbased (CPI) inflation target of four per cent (plus/minus two per cent).

“In the last 14 quarters, inflation has been overestimated by more than 100 bps in six quarters (three in 2014 and three in the most recent period) with an average error of 180 bps (and that too for a very short-term forecast, just three months ahead),” the Survey said.

The Survey also argued that India could be undergoing a “paradigm shift” towards low inflation. “The economy has undergone a transition — possibly structural and permanent — from high to low inflation in the last three years. There has been convergence between CPI and WPI inflation in the last few months. Similarly, there has been narrowing of gap between rural and urban inflation,” it said.

Subramanian has been, in the recent past, critical of the MPC over its refusal to cut key interest rates in the face of low headline retail inflation. But, at its policy meeting earlier this month, the MPC did cut the repo rate by 25 bps.

In June, Subramanian had reacted quite strongly when the MPC held rates. “In recent times, seldom have economic conditions and the outlook warranted substantial monetary policy easing.” He had said that not only headline prices but core inflation had declined as well and that RBI’s “inflation forecast errors have been large and systematically one-sided in overstating inflation”.