Informist, Wednesday, Oct 27, 2021
By Siddharth Upasani and Pratigya Vajpayee
NEW DELHI/MUMBAI - Throughout the COVID-19 pandemic, the Monetary Policy Committee has not fussed much about headline CPI inflation consistently overshooting the 4.0% target that, as per the Reserve Bank of India's glidepath, is now expected to be met only by 2024.
While Ashima Goyal, an external member of the central bank's rate-setting panel, agrees with the temporarily-relaxed approach to inflation targeting, she has questioned the dependence on the glidepath, given the heightened uncertainty.
In A Speech Last Month, RBI Deputy Governor Michael Patra Had Spelt Out A Glidepath For Lowering Inflation
"We don't want to act aggressively on inflation because of a slight deviation from target. Growth should recover first," Goyal says in an interview to Informist. "But I disagree with the glidepath to the extent that I think you cannot confidently speak of a glidepath in such an uncertain time."
"The commodity price rise may be due to shortages that are temporary, but they could persist - or spike due to aggravation by speculative players, which have imparted the sort of volatility we have seen in crude oil prices," she says. "That is why I think our guidance should emphasise the uncertainty around the glidepath."
In a speech last month, RBI Deputy Governor Michael Patra had spelt out a glidepath for lowering inflation. The CPI inflation rate, which has been above the medium-term target of 4.0% for the last two years, is expected to decline from 6.2% in 2020-21 (Apr-Mar) to 5.7% in 2021-22, below 5.0% in 2022-23, and closer to 4.0% by 2023-24.
The Monetary Policy Committee has not mentioned the glidepath in its statements.
Goyal is of the view that the current situation, with economic recovery underway, does not warrant the extent of monetary stimulus that was administered at the peak of the economic shock dealt by the pandemic.
According to her, a gradual withdrawal of liquidity can be performed even while the stance of the policy is accommodative. "I said in the minutes of the August meeting that although the stance remains accommodative, liquidity adjustments can begin since the stance of policy--be it accommodative, neutral, or calibrated tightening--only refers to changes in the repo rate, not to liquidity."
The RBI's absorption of excess liquidity through variable rate reverse repo auctions over the last two-and-a-half months has pushed up short-term costs of borrowing. Goyal does not believe this is a bad thing.
"When one-year-ahead inflation is 5%, you don't want short-term rates much lower than 4.0%. At this stage of the recovery, you don't need really high negative real interest rates," she says.
The following are edited excerpts of the interview:
Q. The Monetary Policy Committee’s focus has shifted from reducing CPI inflation to 4% to keeping it in the 2-6% band. A glidepath for reducing inflation to 4% has been talked about by some members. Is the committee in agreement over this glidepath? Have there been any discussions over the interpretation of the flexible inflation targeting law?
A. The agreement is that as long as inflation is in the tolerance band, the Monetary Policy Committee does not have to give an explanation as to why inflation is deviating from the target. But the aim of inflation targeting is to anchor inflation expectations around the mid-point of 4%. So, I am in agreement with the glidepath in so far as this is an exceptional situation; the economy has faced a severe shock. We don’t want to act aggressively on inflation because of a slight deviation from target. Growth should recover first.
But I disagree with the glidepath to the extent that I think you cannot confidently speak of a glidepath in such an uncertain time. The commodity price rise may be due to shortages that are temporary. But they could persist or spike due to aggravation by speculative players, which have imparted the sort of volatility we have seen in crude oil prices. That is why I think our guidance should emphasise the uncertainty around the glidepath. The target may be achieved earlier, as happened with the crash in oil prices in 2014 on the initial glidepath. It is important to emphasise that commitment to the inflation target is very much there.
Q. In the minutes of the Oct 6-8 meeting, you questioned the amount of surplus liquidity. Do you believe it is now time to start reducing the extent of the surplus to avoid overstimulating the economy?
A. Yes, definitely. I don't think you need the quantity of stimulus that you required at the beginning of the COVID shock. There has been some recovery. What is needed is a gradual adjustment in liquidity. But this is not part of the Monetary Policy Committee's remit.
I said in the minutes of the August meeting that although the stance remains accommodative, liquidity adjustments can begin since the stance of policy--be it accommodative, neutral, or calibrated tightening--only refers to changes in the repo rate, not to liquidity. Day-to-day liquidity management is up to the RBI. The Monetary Policy Committee is not involved in that.
In the last two months, however, liquidity in the system actually rose since India received a lot of inflows. My own view is that liquidity should be somewhat in surplus, but not as much as it is now.
Throughout the 2010s, we had liquidity in deficit. And since India often experiences large shocks that temporarily impact liquidity--outflows, cash leakages, increase in the government's cash balance--the liquidity deficit would become even larger. India is not developed yet: there is a growing modern financial sector as well as a traditional one. But it's only banks that have access to short-term liquidity from the RBI. That is why we need more measures such as targeted long-term repo operations and the system, given these issues, needs to be in surplus.
We also have to make up for the extremely tight monetary-financial conditions through the 2010s. At a time when the rest of the world was doing quantitative easing followed by even more of that once the COVID shock hit, there was hardly any credit growth for Indian households and firms in the 2010s.
Q. You have suggested a higher fixed reverse repo rate for banks, which could be linked to raising their interest rates on deposit accounts. How would this be different from a simple reverse repo rate hike?
A. The reason the Liquidity Adjustment Facility corridor was widened by lowering the reverse repo rate is because banks were just parking surplus liquidity created with the RBI. If what they get from the RBI is less, the inducement to look for other more profitable avenues to lend is more. That would also be a very good way to absorb some of the excess liquidity. But lending has not picked up much.
Moreover, for a year and a half, savers have been getting negative real interest rates. If the reverse repo rate was to rise and banks get more interest on the funds they park with the RBI, and higher interest on fixed rate reverse repo is passed on to depositors, the inducement to look for more profitable lending avenues remains. So, savers benefit and banks don't engage in lazy banking. The European Central Bank has implemented such schemes.
Q. Consumer goods companies have talked in recent days about the cost pressures they are facing and that they plan on taking calibrated price hikes. Considering this would likely push core inflation even higher, is the generalisation of higher input prices a real risk now?
A. Research has established that a lot of these cost pressures are coming in commodities facing supply chain problems due to COVID-19, container and chip shortages, shipping issues, crude oil prices, and so on. Price hikes are more in those areas. The problem is also that there have been multiple shocks, which makes it look like these pressures are persistent.
But it is still not clear from data that the price rises are generalised and persistent. If oil prices continue to climb, the Centre and states can undertake a coordinated reduction in taxes on fuel. They raised taxes when oil prices crashed last year. Now, if oil prices are peaking, they should reduce the taxes somewhat. The government’s revenues are robust now. The COVID-related expenditure should also be decreasing.
It's also worth noting that although firms are talking of cost pressures, data shows they have been able to do a lot of cost saving. Profits are actually increasing. Financial results are very good. So, they should be able to absorb some rise in costs. Why are they talking about margin pressure?
In India, the US kind of income support has not been given. It is not clear that there is excess demand or if demand will be buoyant beyond the festival season. It may be better to absorb cost in a price-sensitive market like India, especially if cost pressures are temporary.
Q. The Monetary Policy Committee has been calling for a cut in the excise duty on fuel products for over a year now. What sort of an excise duty cut would be needed for inflation to come down meaningfully? There are certain estimates that CPI inflation would decline by 15-20 bps from a 5-rupee cut in the duty.
A. There need not be a very large cut in the excise duty. It just has to be something to prevent the one-way upward movement in prices that can affect inflation expectations. We earlier had administered prices in India and fuel prices nearly always rose. Sure, they didn't rise as much when global oil prices were at their peak. But domestic prices also didn't fall much when global oil prices declined. Overall, the path was an upward one. When you move to market-determined prices, prices should move up and down. And that is what is compatible with inflation targeting because then temporary spikes can be looked through.
Q. You've talked about the yield curve flattening and how long rates are important for investment and as benchmarks for private borrowing. But the removal of the Government Securities Acquisition Programme has sent long-term rates surging. At the same time, variable rate reverse repo auctions have pushed up short-end rates. Isn't the message of policy accommodation being lost somewhere?
A. The regular G-SAP programme has been discontinued. But the RBI has not said it will not intervene or not do open market operations.
Last year, when short-term rates were cut, long-rates also fell, but not as much as the short-term rates. So, the spread really widened from what was normally 60 basis points to 200 bps, partly because of COVID-related uncertainty. There was also the enhanced government borrowing to consider. Now it is clear the government has been quite conservative in spending and tax revenues are buoyant. The government probably won’t need to borrow more this year. That is one of the reasons the G-SAP programme has been discontinued.
There are some complications with US yields going up with Fed exit on the horizon, and oil prices and inflation rising. Once these uncertainties are settled, those spreads should come down. That will keep a lid on long-term rates. Let us see after the winter. As for short-term rates, when one-year-ahead inflation is 5%, you don’t want short-term rates much lower than 4%. At this stage of the recovery, you don’t need really high negative real interest rates.
Q. The committee is looking for signs of demand-led inflationary pressures. What would tell you that these pressures are emerging and taking hold?
A. When firms start marking up prices more than the increase in costs, over a broad range of products. We might have already seen that in certain categories like health. But that is because of COVID. It has yet to become more generalised. Sustained high food or commodity inflation is also a danger signal.
My own view of excess demand and potential output in the Indian context is that we discover what potential output is through inflation. There are a range of estimates of potential output available. It is said that post COVID it has fallen even as low as 5.0-5.5%. But if the government is undertaking reforms and reducing cost of doing business and increasing investment in infrastructure, capacity increases. We also have a huge population of young people who are unemployed and large foreign inflows that should be absorbed as investments. If the government is able to manage the supply side and keep costs low so that inflation does not rise, then it is alright to remain stimulative. You don’t need to tighten monetary policy aggressively. If demand stays slightly ahead of supply, that keeps growth going and creates jobs. End
Edited by Vandana Hingorani
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