The MPC’s Commentary Ignores India’s Changed Ground Realities

Context: Monetary Policy Committee (June 2021) opted to keep the policy (repo) rate unchanged at 4% and retain its accommodative stance. But there are indications that monetary policy has reached its limits.

Key misses in MPC policy approach

• Not accounting uncertainties of changed macro-mix scenario: Localized lockdowns and the varying timing and intensity of spread of pandemic across different regions adds to uncertainties in demand build-up and growth prospects.
  • Declined growth impulses: MPC lowered its gross domestic product projection for the year from 10.5% earlier to 9.5%.
• Overlooking inflation pressures: Violating the fundamental principle that once inflation and inflationary expectations become entrenched, monetary policy has only one weapon in its toolkit, hike interest rates.
  • Inflation indications: According to RBI’s Annual Report 2020-21, inflation averaged 6.2% last year, and today, core inflation (excluding food and fuel) remains both high and sticky.
  • Global scenario prompting further inflation: On account of unconventional fiscal and monetary easing, global commodity prices have risen by an average of 80% since the low of April 2020.
• Monetary policy becoming increasingly ineffective: Monetary policy being forced to revive growth in the absence of credible fiscal push which resulted in RBI losing its hold over bond yields and inflation.
  • Failed to incentivize credit growth: Despite flushing liquidity and interventions in bond market, manufacturing activity dropped to its lowest in 10 months in May and consumer sentiment has declined.

Conclusion

• All the above indications suggest that monetary policy has reached its limits, and any further action would be like pushing on a string.
• By ignoring changed ground realities and its implications for evolving growth-inflation mix, MPC has lost an invaluable opportunity to warn markets that monetary policy is not and cannot be a one-way street.