RBI keeps Repo Rate Unchanged!

India | RBI | Banking | Rate | 26th August 2021 | Virtual Wire

The Reserve Bank of India’s Monetary Policy Committee (MPC) in its latest meeting had decided to keep the repo rate unchanged at 4%.

The majority of the members of the MPC also agreed to retain the accommodative stance as long as necessary to help the economy recover from the economic shock of the COVID-19 pandemic.

Accommodative monetary policy, also known as loose credit or easy monetary policy, occurs when a central bank attempts to expand the overall money supply to boost the economy when growth is slowing.

An accommodative stance means a central bank will cut rates to inject money into the financial system whenever needed. RBI has projected 9.5% real GDP growth in the current fiscal year. The MPC has raised its forecast for retail inflation to 5.7%, from the previous 5.1% estimate.

The rising input prices across manufacturing and services sectors, weak demand and the higher-than-expected CPI inflation could dampen economic recovery. There is the possibility of a third wave, especially in the background of rising infections in certain parts of the country.

Aggregate supply is also lagging below pre-pandemic levels possibly due to supply chain constraints and poor investor confidence. Monetary Policy Committee (MPC) member Jayanth Varma has expressed serious reservations about the RBI’s protracted “accommodative” policy stance and has argued that the MPCs forward guidance and stance were in fact becoming “counterproductive” for the Indian economy.

The easy monetary policy has given rise to persistent inflationary pressures in the economy. The MPC’s accommodative stance despite the relatively high inflation levels would create the erroneous perception that the MPC is no longer concerned about inflation and is focused exclusively on growth.

This could lead to the risk of inflationary expectations being disanchored. There seems to be a limited ability of the monetary policy to mitigate the economic impact of the pandemic. The monetary policy is much less effective than fiscal policy for providing targeted relief to the worst affected segments of the economy.

Also given the high possibility of the COVID-19 pandemic persisting for another 3-5 years through the mutations, keeping monetary policy highly accommodative for such a long horizon would be unviable and counter-productive.

The MPC member’s line of argument has been that at a time when the economic recovery is still nascent, it is extremely important that monetary policy serves as an anchor of macroeconomic stability. That would reduce the inflation risk premium and stabilise long-term rates in the economy which is a necessity for sustainable economic recovery.

The central bank seems to be overlooking its mandated function of inflation targeting and the benefits thereof by delaying steps to rein in inflation. Stability in the inflation rate fosters the credibility of the monetary policy framework.

This would help better anchor inflation expectations which in turn will help reduce uncertainty for investors, increases external competitiveness and would thus be growth-promoting.

The central bank’s policies have failed to engender a meaningful recovery even as inflation continues to hover around the upper bound of the inflation target. This raises concerns about stagflation in the Indian economy.

MPC has lowered its growth projections and raised its fiscal-year inflation projection by 60 basis points to 5.7%. MPC must look to simultaneously preserve financial stability through controlled inflation rates and support a durable economic revival.

With crude oil prices at elevated levels, a calibrated reduction of the indirect tax component of pump prices by the Centre and States can help lessen inflation pressure to a great extent.

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