Vote for continuity

Synopsis: RBI should focus more on inflation management.

Introduction

The Union government has given a three-year extension to Reserve Bank of India (RBI) Governor Shaktikanta Das. It shows that the relationship between the central bank and the Union government has improved markedly over the past three years.

Better coordination between the RBI and the government is critical for a country like India, particularly in times of crisis.

How was the central bank’s response to the pandemic ?

Ensured adequate liquidity in the economy: It reduced interest rates and flooded the system with liquidity to avoid any friction in financial markets. For instance, RBI introduced targeted repo operations.

Ensured the proper functioning of financial markets: unlike several other large central banks, it did well to not directly intervene in the corporate debt market.

Eased regulations for common man: RBI extended forbearance at a critical time.

Accumulation of Forex reserves to strengthen India’s external sector: India’s reserves have gone up by over $160 billion since April 2020. The RBI’s intervention is necessary to avoid undue appreciation in the rupee, which can not only affect India’s external competitiveness but also create financial stability risks.

What are the problems faced by RBI during the pandemic?

One area where the RBI has faced problems during the pandemic period is inflation management.

The RBI has been underestimating inflation for quite some time. The average inflation rate in the last fiscal year was above the tolerance band and risks continue to persist.

Should RBI follow IMF’s Suggestion?

The latest India report of the International Monetary Fund suggests that a further accumulation of reserves is less warranted and intervention should be limited to addressing disorderly conditions.

However, RBI will be well advised to not change their position on foreign exchange management. Lower than desired intervention in the aftermath of the global financial crisis, for instance, led to a near currency crisis in 2013.

What is the way forward?

RBI should ensure timely and non-disruptive unwinding of excessive policy accommodation along with bringing the inflation rate close to the 4% target on a durable basis.

This will also require coordination between the RBI and the government because of potential fiscal costs.

Source: This post is based on the article “Vote for continuity” published in Business Standard on 1^st November 2021.