varma-diverged-from-policy-stance-called-for-tightening

Context: A member of the MPC, has strongly argued for tightening the policy stating that inflation and growth risks are “well beyond the control” of the MPC.

Previous Monetary Policy Committee (MPC) key decision

  • While the Reserve Bank’s Monetary Policy Committee (MPC) retained the accommodative stance and kept the main policy rates unchanged in the review earlier.
  • The 10.5% real GDP growth in 2021-22 forecasted by RBI will move in the range of 26.2 to 8.3% in the first half and 6% in the third quarter of 2021.
  • The RBI has decided to restore the CRR in a non-disruptive manner from 3% to 4% in two stages by May 2021.
  • Direct Retail Investment in Government Securities (G-Sec):
  • The RBI has proposed to allow small investors direct access to the G-Sec platform.
  • A G-Sec is a tradable instrument issued by the Central Government or the State Governments and is considered to be the safest form of investment.
  • Accommodative Stance:
    • The Monetary Policy Committee (MPC) of the RBI also decided to continue with the accommodative stance as long as necessary to revive growth on a durable basis and mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward.
    • These decisions are in consonance with the objective of achieving the medium-term target for Consumer Price Index (CPI) inflation of 4% within a band of +/- 2 %, while supporting growth.
    • The CPI calculates the difference in the price of commodities and services such as food, medical care, education, electronics etc, which Indian consumers buy for use.
    • The CPI has several sub-groups including food and beverages, fuel and light, housing and clothing, bedding and footwear.

Concerns by the MPC member

  • A pattern of policy making in slow motion that is guided by an excessive desire to avoid surprises is no longer appropriate.
  • Since August, two other risks that have become salient globally in recent weeks. 
    • The first is that the ongoing transition to green energy worldwide poses a significant risk of creating a series of energy price shocks similar to that in the 1970s. 
    • This means that the upside risks to long term inflation and to inflation expectations are now more aggravated.
  • According to the RBI Governor, going forward, if there are no spells of unseasonal rains, food inflation is likely to register significant moderation in the immediate term, aided by record kharif production, more than adequate food stocks, supply-side measures and favourable base effects.
  • The ongoing worldwide transition to green energy poses a significant risk of triggering energy price shocks similar to the 1970s, which would accelerate inflation. 
  • The sole member of the RBI’s Monetary Policy Committee (MPC) voted against continuing with the central bank’s ‘accommodative’ policy stance.
  • The tail risk to global growth posed by emerging financial sector fragility in China reminiscent of Japan of the late 1980s. Both of these risks are well beyond the control of the MPC, but they warrant a heightened degree of flexibility and agility.
  • The COVID-19 pandemic had mutated into a human tragedy rather than an economic crisis, and monetary policy would be far less effective than fiscal measures in providing targeted relief to the worst hit segments of the economy. 
  • Also, inflationary pressures were showing signs of greater persistence than anticipated earlier.

‘Slow motion’

  • A pattern of policy making in slow motion that is guided by an excessive desire to avoid surprises is no longer appropriate, experts are in favour of raising the reverse repo rate from the current 3.35% towards 4%. 
  • So as to ‘demonstrate the MPC’s commitment to the inflation target, help anchor expectations and enhance macroeconomic stability’.
  • Other members who voted to hold interest rates and retain the ‘accommodative’ stance flagged concerns about the outlook for inflation as the MPC observed that core inflation, inflation excluding food and fuel, remained elevated and sticky at 5.8% in July-August 2021.
  • Core inflation is affected by the prices of transport fuels and transport services that are directly affected by the crude oil price shocks, the reduction in indirect taxes would play an important role in easing shocks on transport costs and overall inflation.

Challenges

  • The RBI’s challenges go beyond the repo rate decision. 
  • As part of the economic stimulus, it had engaged in an emergency bond purchase programme to infuse liquidity into the economy. 
    • However, it has not announced anything specific about the liquidity normalisation procedure, except abstaining from announcing a further G-sec Acquisition Programme (G-Sec). 
  • Another decision to absorb excess liquidity was to tweak the monetary policy corridor — the space between the reverse repo rate and the upper bound of the overnight marginal lending facility. 
  • Tightening the corridor can reverse the “nudging” RBI engaged in by tweaking the reverse repo to help the pandemic-hit economy.
    • However, there was no upwards revision in the reverse repo rate. 
    • The limited calibration was with regard to the cut-off yield of the variable rate reverse repo (VRRR), at 3.99 percent now. 
    • The RBI has chosen to remain “accommodative” rather than moving towards a “neutral” stance.
  • Mounting foreign exchange reserves have increased the liquidity in the economy, and in turn, can increase high-powered money in the system. 
  • Operation Twist — the simultaneous buying (long term) and selling (short term) of bonds to postpone the refinancing risks — was another method to infuse liquidity, as a part of the monetary stimulus package to tackle the pandemic. 
    • However, there are now concerns about a delay in policy normalisation in financial markets. 
    • This is primarily because of the repercussions on the call money market with the overnight call money rates now being below the policy rate. Another concern is the impact of this liquidity on the possibility of fuelling bad credit.
  • The RBI is grappling with multiple challenges — global macroeconomic challenges, which can trigger a capital flight, inflationary pressures and an uneven economic recovery. 
    • In this policy dilemma, it has chosen to give priority to economic growth by keeping the rates status quo.
  • Pressure is also mounting to keep control on the fiscal deficit, which flared up to 9.5 per cent of GDP in the revised estimates for 2020-21. 
    • This is a tricky situation because any normalisation on the fiscal stimulus front is equally detrimental to the economy during a pandemic. 
    • When the efficacy of monetary policy, despite its heavy lifting, has been inconclusive, fiscal dominance is crucial. 
    • Steps towards controlling the fiscal deficit through expenditure compression can have negative repercussions on growth. North Block’s articulation that a high deficit during the pandemic can be substantiated through enhanced capital infrastructure spending is thus welcome.
  • To add to these policy uncertainties, the recent debates on “greening” the RBI have created controversies over the efficacy of the monetary policy reaction function to integrate climate change variables. 
    • The green bonds strategy can open up a political economy question that may limit the degree of freedom the RBI needs to maintain price and financial stability. 
    • Economists also suggest letting the greening of macro policy be “fiscal” in nature.

Related Facts

Monetary Policy Committee (MPC):

  • The Monetary Policy Committee (MPC) is a committee constituted by the Reserve Bank of India and led by the Governor of RBI. 
  • The Monetary Policy Committee was formed with the mission of fixing the benchmark policy interest rate (repo rate) to restrain inflation within the particular target level. 
  • The RBI governor controls the monetary policy decisions with the support and advice of the internal team and the technical advisory committee.
  • Initially, the main decisions relating to interest rates were taken by the Governor of RBI alone before the establishment of the committee. 
  • MPC was constituted under the Reserve Bank of India Act, 1934 as an initiative to bring more transparency and accountability in fixing the Monetary Policy of India. 
  • MPC conducts meetings at least 4 times a year and the monetary policy is published after every meeting with each member explaining his opinions.

Functions: The MPC is entrusted with the responsibility of deciding the different policy rates including MSF, Repo Rate, Reverse Repo Rate, and Liquidity Adjustment Facility.

Composition of MPC: The committee will have six members. Of the six members, the government will nominate three. No government official will be nominated to the MPC.

  • The other three members would be from the RBI with the governor being the ex-officio chairperson. Deputy governor of RBI in charge of the monetary policy will be a member, as also an executive director of the central bank.

Selection and term of members:

  • Selection: The government nominees to the MPC will be selected by a Search-cum-Selection Committee under Cabinet Secretary with RBI Governor and Economic Affairs Secretary and three experts in the field of economics or banking or finance or monetary policy as its members.
  • Term: Members of the MPC will be appointed for a period of four years and shall not be eligible for reappointment.

How decisions are made? Decisions will be taken by majority vote with each member having a vote.

RBI governor’s role: The RBI Governor will chair the committee. The governor, however, will not enjoy a veto power to overrule the other panel members, but will have a casting vote in case of a tie.

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