Edited by Sanjana More, a first year economics student.
Luvya Khushalani is a first year economics student at Jindal School of Governance and Public Policy.
Overview
2020 to 2023 has been a tumultuous time for Central Banks and their monetary policies. In just a span of three to four years, most banks were forced to go from one end of the spectrum to another owing to tectonic shifts in the world as we know it. Over the coming pages, the aim is to explore the aforementioned topics in-depth and look into what the future holds for monetary policy in India.
The Monetary Policy Committee
The Monetary Policy Committee (hereafter ‘MPC’) of the Reserve Bank of India [1], constituted in 2016 under Section 45ZB of the RBI Act held its forty-first meeting from February 6 to 8, 2023. The meeting was much anticipated and without surprise, revolved around inflation and policies to control it. However, that is not to say that the meeting was all about inflation, as; (i) inflation and associated policies, as we will see, have many aspects, and (ii) given how much hype the media creates about price pressures in the economy, it is easy to forget to look beyond a few months.
From the Horse’s Mouth: Governor’s Statement
The Governor, delivering his statement [2] on February 8, 2023, emphasised, how in merely the past three years, monetary policy has been pushed to both extremes given the shocks to the global economy. It is truly unprecedented that in such a short period of time (macroeconomically speaking), we experienced large-scale contractions and then proceeded to face great inflationary pressures.
This problem is particularly stark for Emerging Market Economies (EMEs) which are forced to walk a tightrope between controlling inflation and aiding economic growth/recovery.
He then proceeded to talk about how, considering India has now assumed the presidency of the G20, global cooperation is paramount, with India being looked upon to “energise global partnership in several critical areas.”
Throughout his statement, which we will delve deeper into, there were some fundamental themes worth bringing up:
a) The Indian economy remains resilient, and outlooks remain optimistic despite inflationary pressures, which is something that the MPC has brought up repeatedly over the past year and rightly so.
b) That inflation is subsiding and showing signs of moderation and considering the same, a more conducive macroeconomic situation is fast arising.
c) In recent times, the Indian Rupee has remained one of the least volatile currencies over the past times.
d) Reiteration that the RBI is to remain proactive and continuously assess the impact of its policies, further acting accordingly when needed.
The Governor, in his statements, went on to present the RBI’s assessments, provide comments on macroeconomic issues, make announcements regarding monetary policies and provide a future outlook; each of which we will explore further.
What Comments and Assessments has the RBI Made?
Speaking about the global economic situation, the RBI evaluated that while the global economic growth outlook does not look as grim as it did some time ago, the situation remains very fluid owing to price pressures, which while easing, remain well above target.
Slowing external demand, a tense geopolitical situation and the general trend of tightening monetary policy (i.e. the prevalence of conservative measures like raising repo rates) still give policymakers causes for concern. However, the Bank was relieved by the retreating US Dollar, the surge of which was putting further stress on some aspects of the economy.
Coming back to India, extensive commentary and assessment of the same were provided. [3] The Indian economy, as per the RBI, has remained strong and resilient over the past years, seeing rapid recovery, and defying many global growth trends. In a world of uncertainty, India has emerged as a hub of growth, experiencing a 7% increase in real GDP (as per the National Statistical Office estimate).[4]
This has been credited to investor confidence, strong urban demand, rising rural demand, credit expansion and liquidity, investment in capital and infrastructure as well as a growth-focused union budget. The Governor, responding to a question by a Bloomberg journalist [5], clarified that the Bank does not fear a resurgence of inflation and remains confident that enough has been done to aid economic growth.
However, it did not paint an all-rosy picture and pointed out in detail the drags on the Indian economy. While it applauded the fact the Consumer Price Index inflation had moved below RBI’s upper tolerance levels, concerns were raised about core inflation (which differs from CPI inflation in the sense that it excludes prices of goods from the food and energy sectors) that remained well above what could be comfortably tolerated. The aforementioned are only exacerbated by rising crude oil prices.
As discussed in the beginning, inflation is not the only thing at play here. Our economy also faces challenges owing to slowing external demand (leading to declining exports) and yet again, the constantly evolving and tense geopolitical situation in Europe.
Key Terms
Before proceeding further, let us define a few key terms:
1. Repo rate: the rate at which the RBI lends money to commercial banks, increasing the repo rate reduces the flow of money and vice-versa.
2. MSF: Marginal Standing Facility. A facility for banks to borrow from the RBI in a situation when inter-bank liquidity is exhausted. It is +0.25% of the repo rate.
3. SDF: Standing Deposit Facility. A facility that allows banks to store their excess liquidity with the RBI without any collateral. This is a measure used for reducing the money supply in the economy. This is -0.25% of the repo rate.
4. Basis Point: 1 Basis Point (BP) = 0.1%
Tracking Monetary Policy 2021 Onwards
2021-2022
RBI’s focus and aim with its 2021- 2022 policy were very different from what we see today. As detailed in the annual report [6] (officially titled The Annual Report on the Working of the Reserve Bank of India), they at the time remained focused on mitigating the impact of the pandemic and promoting durable growth. Inflation, even though aimed at keeping it within limits, was more of a secondary thing than something of absolute importance.
Through much of 2021- 2022, the repo rate was maintained at 4% (compared to the current 6.5%). Even when inflationary pressures began to exacerbate to 5.3% (overall 2021-2022), the 4% repo rate was still maintained along with MSF at 4.25% and SDF at 3.75%.[7] During this time, the extensive focus was on creating liquidity and expanding credit.
The 2021-2022 Annual Report6 details RBI initiatives at the time aimed at the aforementioned, rapidly expanding lending operations (at times more than peer countries), especially to MSMEs, health, medical supplies, and other contact-intensive sectors. Multiple lines of credit were established, and many liquidity windows were opened to support the economy. These initiatives were paired with the Central Government’s expenditure on capital and manufacturing, aiding private investment.
That is not to say, however, that the RBI was ignorant of other factors, as it did express major concerns over the impact of the Russia-Ukraine War, talking about inflation and energy concerns in its Monetary Policy Report 2022. [8]
Talking about its aims for 2022-2023 in its communications [9], the Bank planned to continue its focus on liquidity and economic support while keeping inflation in mind. There was little to suggest that inflation would become by far the most important aspect of policy.
We should keep in mind that despite all of this, the state of the Indian economy continued to improve, with the NSO later placing GDP growth at 8.9%. [10]
2022-2023
The first MPC meeting of 2022 was held on April 6-8 and by this time, things had taken a drastic turn given the onset of the Russia-Ukraine War. While the repo rate, LAF, MSF and SDF remained the same, inflation became the absolute prime concern of the bank as it pointed towards the worsening of the global economic situation due to geopolitics, especially impacting crude oil prices, which reached a 14-year high. While by April 2022, oil prices had been controlled to some extent, they remained volatile and exacerbated the then-easing supply chain pressures. April 2022 marked a turning point in the MPC priorities, with the Governor clearly stating that “we have now put inflation before growth”[11], a reversal of the 2019-2022 policy focus that put growth (at times much) ahead of inflation.
Things were still murky at the time, primarily revolving around inflation outlooks, which hinged on the developing geopolitical situation. Tightening of monetary policies and supply-side disruptions weakened external demand, however, the MPC was of the (unanimous) opinion that until the situation becomes more apparent, major policy rates should be maintained in order to continue supporting the ongoing recovery.
Over the course of the next MPC meetings, we would observe a steady increase in major policy rates as CPI headline inflation rose to 7.8%. In May 2022 [12], the repo rate would increase by 40 basis points (0.4%) to 4.4% and by June 2022 [13], the same would stand at 4.9%. This was done while also pointing towards the strong domestic recovery, with GDP growth forecasts being maintained at 7.2%.
The meetings of August 2022 [14] brought together varying circumstances where, even though headline inflation eased to 7%, fuel inflation still remained in double-digits, prompting the MPC to further push the repo rate to 5.4% (an increase of 50 basis points). The MPC remained optimistic about GDP growth owing to strengthening rural demand. This was also a time when the US dollar saw a two-decade high, and many countries witnessed the weakening of their currencies.
Inflation and geopolitics would continue to dominate MPC discussions and resolutions, as marked by two further increases in repo rates, September 2022 [15] and December 2022 [16], by 50 basis points (to 5.9%) and by 35 basis points (to 6.25%) respectively. In both instances, however, it is interesting to note that domestic growth remained resilient with increasing investment, rising urban demand, a good agricultural yield, and expanding raw material production. Inflation, though moderating towards the year-end, remained above the upper-tolerance level of 6%.
This time kept the MPC on its toes, constantly analysing impacts and making amends to its policies. The committee remained impressively “watchful and nimble”[17] during the entire time. How effective (or not) their policies were, is up to the experts to determine, but regardless, the fact remains that by December 2022, inflation was settling down and it was declared that “the worst of inflation is behind us”. The overall economic situation remained resilient in a world of gloomy prospects.
The last meeting of the MPC for the financial year was held on February 6-8, 2023, which would see yet another increase of the repo rate by 25 basis points to a high of 6.5%. This was even though CPI headline inflation moderated to 5.7% (below the upper tolerance of 6%), core inflation rose to 6.1% with further stress created by food and fuel inflation, which has the potential to kick up headline inflation again. It could be said that this further increase in the repo rate was a strong precautionary measure. The RBI held a 7% real GDP growth rate forecast for FY 23-24. [18]
It is worth noting that while almost all previous MPC meetings had a unanimous vote for hikes, the February meeting saw two members (namely Dr. Ashima Goyal and Prof. Jayanth R. Varma) vote against the hike. They later explained their rationale, saying they believe that the MPC has done enough for inflation and that further rate increases could lead to reduced demand and might risk over-correction. They believed the best course to be to wait and see the effects of previous policies to be played out. [19] Even though only time will tell if their concerns were valid, they make a strong case as, in an overcompensation scenario, the MPC risks putting itself in a vicious correctional cycle of raising and lowering rates, in the process destroying its own purpose of achieving stability.
Speaking at the post-meeting press conference [20], the RBI governor reiterated that the worst of inflation is behind us (which is corroborated by inflation figures for the most part).
Conclusion
It is now time to bring all of the aforementioned to a close. While it is true that monetary policy and inflation are complex topics with a host of factors, aspects, and figures attached to them, everything is easier to understand when put into context and a chronological order. Even before the pandemic began, the MPC (and by extension, the RBI) was focused on aiding economic growth through the right monetary policies. After the pandemic began, growth, already a priority for the Bank, was stimulated by easing monetary policies, maintaining liquidity, opening up lines of credit and so on. The pandemic saw the MPC nearly pushed to one side of the extreme (growth only), nearly (and not completely), as the MPC was aware of these potential inflationary risks but times were such that they believed it had to be done. This continued until about February 2022 when the Indian economy began to recover from the pandemic. The time between February 2022 and April 2022 was a delicate one as the geopolitical situation in Europe unfolded and the MPC was at the crossroads.
However, as the economy recovered and the geopolitical situation took a turn for the worse, supply-side and price pressures shot up rapidly, forcing the MPC to make a U-turn from its pre-2022 monetary policies, which had growth at number one, to making inflation as the number one priority. Since then, the RBI has been pushed to the other extreme and has consistently raised policy rates until February 2023 in order to counter inflation.
It is worth noting that inflationary pressures would perhaps still be present, regardless of the war in Europe, considering the massive infusion of liquidity and government expenditure that took place during the pandemic. The educated guess, however, is that it would have been (i) lesser and (ii) much more gradual.
After the February 2023 MPC meeting, as communicated via the press conference [21], the resolution passed in the meeting [22], and the minutes of the meeting[23], the MPC remains confident in India’s growth trajectory as well as easing inflation. We look forward to a more relaxed new fiscal year
Looking Ahead: 2023-2024
As the FY came to an end, the state of the Indian economy can be summed up by pointing towards its general resilience. While the pandemic hit the economy hard, India was quick to recover, has stayed on the course and does not show any major signs of slowing down. While inflation is still a concern, growth still remains well in the positive while price pressures continue to ease. The MPC aims to ease up going ahead and it has stated that it does not wish to and does not expect any further monetary tightening.
Growth prospects are increasingly optimistic even as the world continues to grapple with geopolitical tensions and pressures. India remains a beacon of hope and we expect the monetary policy for 2023-2024 to be in accordance with the same. The MPC is expected to ease up policy rates (though with caution) over the coming FY and growth is expected to regain the top position on the monetary policy objectives list again.
All this being said, this will not happen immediately and will probably take the entire upcoming FY as the MPC will undoubtedly do its due diligence and be cautious in its easing while also aligning itself closely with the Union Government’s growth and fiscal objectives which, as reflected in the 2023-2024 Union Budget, are to promote stability, increase capital expenditure, boost domestic demand, develop infrastructure, and promote a green economy. Fiscal consolidation is also expected to free up productive resources. Given the recent pressures on banks (most prominently, problems of the mammoth sized Credit Suisse), it will be interesting to see discussions and decisions in the upcoming MPC meeting.
Overall, even though the MPC’s actions divide opinion, it is worth appreciating how it was at the forefront all this time, constantly analysing and reassessing its actions, and acting accordingly. We live in an interesting period for macroeconomics considering the rapid changes over a short period, which has ensured that our time will be studied and analysed for years to come. What was true yesterday might no longer hold up to academic scrutiny today, and as more data comes around and we update our insights, you might well find us criticising the MPC’s actions only a few months down the line.
Bibliography
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[1] (Government of India, 1934)
[2] (Reserve Bank of India, 2023)
[3] (Reserve Bank of India, 2023)
[4] (National Statistical Office, 2023)
[5] (Reserve Bank of India, 2023)
[6] (Reserve Bank of India, 2022)
[7] (Reserve Bank of India, 2022)
[8] (Reserve Bank of India, 2022)
[9] (Reserve Bank of India, 2022)
[10] (National Statistical Office, 2022)
[11] (Das, 2022)
[12] (Reserve Bank of India, 2022)
[13] (Reserve Bank of India, 2022)
[14] (Reserve Bank of India, 2022)
[15] (Reserve Bank of India, 2023)
[16] (Reserve Bank of India, 2022)
[17] (Reserve Bank of India, 2022)
[18] (Reserve Bank of India, 2023)
[19] (Reserve Bank of India, 2023)
[20] (Reserve Bank of India, 2023)
[21] (Reserve Bank of India, 2023)
[22] (Reserve Bank of India, 2023)
[23] (Reserve Bank of India, 2023)
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