Planning an Exit Out of the Easy Money Regime

The Hindu     11th January 2021     Save    

Context: To facilitate a non-disruptive exit out of the easy money regime, the Reserve Bank of India (RBI)’s main challenge would be in managing the tension between restraining inflation and supporting recovery.

Challenges of the RBI:

  • Restraining inflation:
    • Rise in food inflation and core inflation due to rise in input prices.
    • Demand recovery may not result in lower inflation: if firms raise prices to counter losses.
    • Low-interest rates: discourage savings.
  • Downside risks to growth:
    • Fragile economic recovery: further complicated by an uneven and unequal recovery of small and medium enterprises and the entire informal sector.
    • Unemployment: driven by labour retrenchment policy of big firms to cut costs.
  • Withdrawal of the ‘excess’ liquidity: Excess liquidity can result in -
    • Mispricing of the risk: which often becomes the cause for a financial crisis.
    • May result in possible market tantrums: For E.g. the ‘taper tantrums’ that reverberated across global markets when US Federal Bank decided to gradually taper ‘quantitative easing’.
  • Managing ‘the impossible trinity’: Which includes managing capital flows while simultaneously maintaining a stable exchange rate and restraining inflation. Challenges include -
    • Limited capacity to prevent exchange rate appreciation: due excess liquidity led to inflation and the risk to financial stability.
    • Upward pressure on the rupee: due to the current account surplus this year together with massive capital inflows.

Way forward:

  • Ensure deliberative process: For reversing a crisis-driven expansionary policy.
  • Effective communication strategy: as RBI makes liquidity withdrawal, in order to avoid a ‘taper tantrum’ like situation.

Conclusion: It is better to be rough right, as Keynes said than be precisely wrong. That should be the guiding principle for RBI as it navigates its way out of the crisis-driven easy money policy.