It was expected that the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) would keep the policy rates unchanged and maintain its accommodative stance. Even as it did so last week, there were indications that continuing with the growth-supportive stance was becoming increasingly difficult, with inflation obstinately remaining above the comfort zone. The benchmark interest rate is at the decade’s low, and the RBI has ensured that there is enough liquidity in the system. But growth rates have not responded well to the policy directions and it is unlikely that the situation will change for the better in the near future. The RBI has retained its full-year GDP growth forecast at 9.5%, but lowered the Q2, Q3 and Q4 growth projections it made two months ago. The projections from other agencies are less optimistic.
The MPC has said that economic activity has started recovering with the waning of the second wave of the pandemic. It hopes that agriculture will perform well and there will be an increase in rural demand. There is also an expectation that the recovery of industry and services will boost urban consumption, and increased vaccinations will improve matters. All of these assumptions may go wrong. The monsoon deficit has affected kharif sowing and may affect farm growth. Business activity has slowed down in the past few weeks, according to the Purchasing Managers’ Index (PMI). Employment has not picked up. Consumer confidence is low. The pandemic situation is still uncertain and vaccination numbers have till now not kept pace with the targets. Bank credit growth has been negative in all months of the current financial year. All this indicates that recovery is not going quite as well as expected.
On the other hand, the inflation forecast for the current financial year has been raised from 5.1% (as assessed in June) to 5.7%, which is only 30 basis points below the RBI’s tolerance limit. The RBI has till now held that the inflationary spike is a “transitory’' phenomenon, and promised to do “whatever it takes’’ to promote growth. But this position seems to be weakening, as seen from the lack of consensus among the MPC members over the stance. While five members voted to persist with the stance, one member expressed reservations. While prices are rising in India, commodity prices are firming up across the world. There are other global triggers, too, which will have an impact. Failure to address the inflation challenge in time may carry a risk, as negative interest rates cannot be sustained for long. The risk is greater when there is no fiscal action from the government. The RBI may soon have to change its stance.