Informist, Monday, Aug 28, 2023
--MPC Goyal: Real rate of 1%, supply-side actions to lower CPI to 4%
--MPC Goyal: CPI fall to 4% depends on how supply shocks are managed
--MPC Goyal: No signs of food inflation becoming generalised yet
--MPC Goyal: Fiscal action has a greater effect on food prices
--MPC Goyal: Govt better equipped than RBI, MPC to curb food price shocks
--Goyal: Extra CRR discussed at meet, but liquidity not MPC mandate
--MPC Goyal: Liquidity should not be in excess or in too much deficit
--MPC Goyal:Rate cuts possible if CPI seen sustainably near 4% target
--MPC Goyal: Forecasts not yet clear on when CPI sustainably nears aim
By Shubham Rana
NEW DELHI – The government's fiscal tools are more effective to fight primary food price shocks than the monetary ammunition of the Reserve Bank of India or its Monetary Policy Committee, says Ashima Goyal, external member of the central bank's rate-setting panel.
"Yes, the government is better equipped than either the RBI or the MPC to fight primary food or oil price shocks with steps to reduce costs and commodity prices," Goyal tells Informist in an interview after the minutes of August MPC meeting were released last week.
"Inflation in cereals and pulses takes longer to subside, but it is more amenable to trade and buffer stock polices, in which the government has long experience," she says.
Headline inflation has risen sharply since the rate-setting panel last met in June, with CPI inflation rising to a 15-month high of 7.44% in July mainly due to a surge in retail prices of vegetables, particularly tomato.
On Aug 10, the six-member rate setting panel unanimously decided to keep the repo rate unchanged at 6.50%, and voted with a majority of 5-1 to maintain the 'withdrawal of accommodation' policy stance.
Asked if she will think about voting for a rate hike if food inflation continues to push headline CPI higher beyond Jul-Sep, Goyal says: "It also depends on other evidence of second-round effects occurring, such as higher wage growth, etc. And if one year ahead, inflation forecasts rise so the real rate is expected to be negative."
Goyal says a real repo rate of around 1%, along with supply-side actions, is enough to lower inflation to the 4% target without a large growth and employment sacrifice. "MPC's commitment to inflation-targeting and keeping real repo rates positive contributes by anchoring inflation expectations, preventing second-round effects, and overheating of demand," says the professor at Indira Gandhi Institute of Development Research.
Asked about the non-interest rate tools that the RBI and the MPC could use to fight inflationary pressures, Goyal lists the "inflation expectations channel, intervention to prevent overshooting of the exchange rate, and communication".
In the policy statement on Aug 10, the central bank had announced an incremental cash reserve ratio of 10% on the increase in net demand and time liabilities of scheduled banks between May 19 and Jul 28. The move was estimated to suck out over 1 trln rupees of liquidity. Goyal says this move on incremental CRR was discussed at the MPC meeting, but liquidity is not part of the committee's mandate and that it is the RBI's domain.
"In an inflation-targeting regime, however, short-term liquidity has to adjust to keep overnight rates near the repo rate set by the MPC. To fight inflation, liquidity should not be in excess, but not too much in deficit either," Goyal says.
Following are the edited excerpts of the interview:
Q. RBI's estimates don't show inflation below 5% till Apr-Jun next year. Does this not make the case for another rate hike?
A. At a repo rate of 6.5% and expected inflation of around 5%, the real repo rate is still around 1%, which is adequate, along with supply-side action, to bring inflation towards the target without imposing a large output and employment sacrifice. Since interest rates work with lags, we are concerned with the real repo rate calculated with one year ahead expected inflation.
Q. When do you see inflation coming down to 4%?
A. Core inflation is softening and volatile headline inflation converges to core inflation, which is steadier. How long it takes depends on supply shocks and how they are managed.
Q. Do you think food inflation is becoming more generalised and is not just limited to the TOP (Tomato, Onion and Potato) vegetables?
A. Inflation in cereals and pulses takes longer to subside, but it is more amenable to trade and buffer stock polices, in which the government has long experience. Inflation is generalised if there are second-round effects on wages. There are no signs of that as yet.
Q. If food inflation continues to push headline CPI higher beyond Jul-Sep, will you then think about voting for a rate hike?
A. It also depends on other evidence of second-round effects occurring, such as higher wage growth, etc. And if one year ahead inflation forecasts rise so the real rate is expected to be negative.
Q. Given that the current bout of inflation is mainly led by food prices, does that crimp the space the Monetary Policy Committee has for action?
A. Fiscal action has a greater effect on food prices.
Q. You have suggested more steps that the government can take to control inflation. Are the RBI and the government more equipped to fight inflation right now, than the MPC?
A. Yes, the government is better equipped than either the RBI or the MPC to fight primary food or oil price shocks with steps to reduce costs and commodity prices. But MPC's commitment to inflation-targeting and keeping real repo rates positive contributes by anchoring inflation expectations, preventing second-round effects, and overheating of demand.
Q. Was the incremental CRR, or any other non-interest-rate tools, discussed at the MPC meeting to fight inflation? How do you view this move by the RBI and what other non-rate tools can the MPC or RBI use?
A. It was discussed, but liquidity is not included in the MPC's mandate. It is the RBI's responsibility. In an inflation-targeting regime, however, short-term liquidity has to adjust to keep overnight rates near the repo rate set by the MPC.
To fight inflation, liquidity should not be in excess, but not too much in deficit either. The inflation expectations channel, intervention to prevent overshooting of the exchange rate, and communication are other tools the MPC or RBI can use.
Q. As per RBI's latest inflation and growth projections, when do you think rate cuts look like a possibility?
A. Rate cuts are possible if inflation is seen to be sustainably approaching the target. The forecasts do not show that as yet.
Q. You had said in April that if commodity and food price inflation sustains higher, we may need a higher inflation target. Does the current bout of higher food inflation reinforce the belief that we need a target higher than 4%?
A. The target is set by the government. It is for them to take a call. But Indian inflation also has to be aligned to international, and major economies seem to be sticking to their inflation targets.
Q. You have said that oil companies have space to cut prices. Do you think oil companies will actually cut retail prices to help ease inflationary pressures, since the government has limited fiscal space to cut excise duty?
A. In a market-determined system, they should be transmitting international oil price changes. This was suspended after the Ukraine war, but has to eventually be resumed. End
Edited by Ranjana Chauhan
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