RBI’s Monetary Policy and the art of letting it be — on recent monetary policy decisions

Source: This post has been created based on the article “RBI’s Monetary Policy and the art of letting it be” published in the Indian Express on 7^th October 2023.

UPSC Syllabus Topic: GS Paper 3 Indian Economy — issues relating to planning, mobilization of resources, growth, development and employment.

News: The article discusses the reasoning behind RBI’s tight monetary policy and the inflationary trends and growth projections of India considering various domestic and external challenges.

The Monetary Policy Committee (MPC) kept the policy interest rates unchanged and retained its stance of ‘withdrawing accommodation’ (or a “tight monetary policy”).

Here, accommodative monetary policy refers to a strategy used by central banks that is aimed at keeping interest rates low in order to infuse more cash into the economy.

Why the ‘withdrawal of accommodation’?

Both domestic and external reasons are behind this policy stance.

Domestic Reasons:

1) Unanticipated and uncontrollable risks to inflation — such as the huge rise in prices of tomatoes and other food items.

2) Incomplete monetary policy transmission of past rate hikes. Hence the MPC decided to hold its stance.

External Reasons:

1) The continuation of Hawkish (or tight) monetary policies by systemically important central banks, particularly by the US Federal Reserve.

2) The rise in crude oil prices.

What are the implications of monetary policy on the economy?

In the developed world, monetary policy is at a delicate juncture. Too much tightening could lead to recession in the economy; less tightening could lead to high inflation.

The positive outcome of tight monetary policy stance by the US Federal Reserve is the US 10-year treasury yields going up. This is attracting capital to the USA and away from the emerging markets and strengthening the dollar. This has also resulted in the depreciation of the rupee.

What does the inflation scenario in India look like?

1) The recent tomato-led surge in vegetable inflation spiked the Consumer Price Index. However, fresh arrivals have corrected the inflated vegetable prices.

2) Double-digit inflation in cereals, pulses and spices.

3) Overall kharif sowing is only marginally above last fiscal’s level and lags for pulses and jute.

4) El Niño conditions and Lower water reservoir levels compared to last year and the decadal average may also impact the rabi or winter crop.

6) Crude oil prices have emerged as another potential risk. India is at high risk as 85% of its crude oil is imported. Geopolitics and squeezing of the supply by oil-exporters may lead to a rise in crude prices despite weakening global demand.

What are the growth projections for India considering this?

The RBI has retained its GDP growth outlook at 6.5% for this fiscal. However, CRISIL has lowered it to 6% due to the following challenges:

1) Global economic slowdown and decrease in exports.

2) Curbing of consumption demand due to domestic interest rate hikes.

3) Erratic weather and El Niño curbing agricultural growth.

4) Persistent supply shocks from food or fuel can transmit to other parts of the economy and broad base inflationary pressures.

India’s growth has been robust despite costlier crude oil, weakening rupee and pressure on food inflation from an erratic monsoon. However, supply shocks amid healthy growth will keep the RBI cautious.