RBI Rates Policy: Why Collective Action Is Key To Winning The War Against Inflation

As expected, Reserve Bank of India (RBI) hiked the repo rate by 25 basis points to 6.5 per cent while retaining its ‘neutral stance’ in its third bimonthly monetary policy statement. The move is in consonance with views of many economists and think tanks. Very few have expected status quo. The move may curb demand-pull inflation but its impact on cost-push inflation may eventually bounce back and accentuating woes. Retail inflation stubbornly climbing close to 5 per cent in May and June 2018 added to the discomfort, particularly when RBI is set to contain headline inflation within the prescribed glide path. Even findings of the RBI’s household survey indicated a further uptick in inflation by another 20 basis points, adding to the concern.

Going by the impact of measures now taken, the inflation outlook is expected to be maintained at around 4.6 per cent in first half (H1) and 4.8 per cent in second half (H2) during the current fiscal. It is expected to be around 5 per cent in financial year 2020 (FY2020). Since inflation impacts life of every segment of the community, containing it is in the larger interest. Moreover, the interest rates have not yet reached a level to cause concern to growth prospects; rather the worries are more to ensure the flow of credit to the productive sectors of the economy.

1. External factors

In the meantime, other inflation dynamics in the external sector may turn supportive. The softening crude prices on higher supplies by the Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC suppliers may continue. However, geopolitical tensions and escalating trade war will impact foreign trade, widening the trade deficit and the current account deficit (CAD). The double-digit imports due to rising oil prices has already bloated trade deficit.

Similarly, the diminishing capital flows to emerging market economies (EMEs) in the backdrop of rising interest rates in US can disturb capital market equilibrium. The resultant gyrations in forex reserves down to $404.2 billion on 27 July 2018 compared to a high of $426.02 on 13 April 2018 are evidence of upside external risks. The capital outflows can be recovered only if the macroeconomic fundamentals are intact. RBI continued to retain gross domestic product (GDP) outlook at 7.4 per cent for FY2019. The granular outlook is expected to be range-bound between 7.5 per cent and 7.6 per cent in H1 and 7.3 per cent to 7.4 per cent in H2.

2. Domestic factors

When pursuing an inflation-centric policy, domestic factors are more significant. Though the south-west monsoon has been making up its uneven coverage, it is a cause for concern that eight out of 36 sub-divisions are receiving scanty rainfall, impacting the sowing trends. The residual phase of monsoon needs close monitoring to assess farm sector efficiency.

According to RBI, the total sown area during kharif crop is 7.5 per cent less than last year, with its likely cut on future farm output. Further, the exact assessment of the impact of rise in minimum support price (MSP) equal to 150 per cent of input cost will be difficult but fiscal disequilibrium, if any, can push up inflationary head winds. The uptick in input cost to industry may not only push up manufacturing costs but can also slow down industrial growth. RBI’s industrial outlook survey showed higher input costs and selling prices can put pressure on productivity. Farm and non-farm inputs costs too have increased more significantly. The positive signs are the performance of national highways and rural housing, which can ease demand-side, pushing up sales of related products and services.

3. A collaborative function

Inflation control is not solely possible with RBI policy moves. The efficiency of its transmission and the role of other stakeholders are more important. RBI can send policy signals that warrant a course-correction, but its actual outcome will depend on follow-up action by its interdependencies. In this league, dissemination of credit will hold more significance to make enterprise work. During the current fiscal, the year-on-year (YOY) growth of credit is good at 12.8 per cent as on 6 July 2018 as against deposit growth of 8.3 per cent, but what is more worrying is the dismal flow of credit from public sector banks (PSBs) ailing under mounting bad loans. With 11 out of 21 PSBs under Prompt Corrective Action (PCA) with attendant functional restrictions, the flow of credit to the grassroot level of the economy may not be adequate to support growth.

Looking to past the trends of credit growth during FY18, PSBs recorded 4.7 per cent rise whereas private banks could increase it to 20.9 per cent, a phenomenal difference. The inability of PSBs to measure up to the demand for credit may lead to tardy growth prospects. If the same trend continues during this year, the lopsided credit growth will hit hard the rural enterprise. Similarly, the supply side dynamics of commodities, more importantly the food and consumable items must be addressed by removing bottlenecks of transport disruptions.

4. Way forward

RBI very thoughtfully proposed a new concept of co-origination of loans by banks in collaboration with systemically important non-banks for lending to the priority sector. It has to be seen as to how banks will be able to partner with them and how it can pan out to emerge as a win-win value proposition. The operational guidelines will set the right direction and can highlight the merits of the scheme. But the very idea can supplement credit flow to the micro sectors of the economy which cannot access loans from other than banks. Most of the priority sector borrowers are bank-dependent for their credit needs.

On the whole, the RBI policy move clearly highlights its inflation control bias with concerns for adequacy of flow of credit to productive sectors of the economy. The added innovation in tagging non-banks to strengthen credit dissemination can help enterprise. The long-term vision of RBI is evidently pointed towards long-term growth stability by effectively modulating short-term dynamics. But the war against inflation can be won only if collective and inclusive action and coordination among stakeholders are ensured.