Navi Mumbai: A view of the wholesale vegetables market at Vashi, in Navi Mumbai, Friday
Credit: PTI Photo
On October 9, the Reserve Bank of India (RBI) Governor Shaktikanta Das announced the decisions taken by the six-member Monetary Policy Committee (MPC) in its fourth bi-monthly meeting of the current financial year (FY). It kept the policy rate (the interest rate at which the RBI lends to banks) unchanged at 6.5%. However, it altered its policy stance from “withdrawal of accommodation” to a neutral stance.
The RBI fixes the policy rate in such a manner as to maintain the Consumer Price Index or CPI (it corresponds to a basket including food, fuel, manufactured goods and select services) within the target range of 4% (+/- 2%). A decision in this regard is taken once in two months during each FY. The other crucial policy instrument it uses for targeting inflation is Liquidity – a jargon for the quantum of credit available in the banking system.
Pumping more liquidity along with a reduction in the policy rate represents an ‘accommodative’ policy stance. The term was coined by Das in 2019 when he started going for aggressive cuts in the policy rate and an increase in credit availability. He reduced the policy rate from a high of 6.5% in February 2019 to 4% by May 2020. It stayed at that level for over two years.
Beginning May 2022, the RBI delivered a hike of 2.5% (1.4% in the first half and 1.1% in the second half of FY 2022-2023) restoring it to 6.5% by February 2023. Since then, the rate has remained unchanged. All this happened even as it changed its stance from June 2022 to “withdrawal of accommodation” and had stuck to it till October 8, 2024. From October 9, it has decided to go for what it terms a “neutral” stance. A neutral stance connotes that the RBI has now decided to keep its options flexible.
Have these decisions delivered?
Despite a hike in the policy rate by a steep 2.5%, CPI inflation hovered around 8% during FY 2022-23. The reason was a sharp increase in prices of food, fuel and fertilisers, courtesy the Ukraine war. Food prices also got a boost due to unseasonal rains during Rabi 2022-23, accompanied by hailstorms. Both factors work on the supply side whereas monetary policy operates on the demand side.
During FY 2023-24, even as pressure from the supply side eased especially from the second half, CPI inflation decreased to 5% in September 2023, 4.8% in October 2023 and 5.1% during January/February 2024. The trend has continued during the current FY. In July 2024, it touched a low of 3.54%. Following the principle set by none other than itself, the RBI ought to have reduced the policy rate. But, it hasn’t.
This has to do with a mindset that was reflected in Das’s observation while deciding against any cut in the April 2024 policy statement. He had said: “The elephant has now gone out for a walk and appears to be returning to the forest. We would like the elephant to return to the forest and remain there on a durable basis.” Put simply, he meant there was no need to start reducing interest rates until inflation reached the target of 4% and stayed at that level. If that figure of 4% was so sacrosanct, then why keep the (+/- 2%)?
Even now, the RBI continues with this mindset. A potent reason for the spurt in CPI is food inflation which has a weightage of around 40% in the index. Food inflation is impacted the most by supply side/seasonal factors. It can be contained only by addressing those very factors. The RBI can achieve little either by keeping the policy rate high or reducing credit availability.
While formulating its monetary policy, the RBI’s prime responsibility is to ensure macro-economic stability, its pivotal focus being on keeping inflation within reasonable bounds. But it needs to adopt a flexible approach. ‘Inflation Targeting’ in a mechanical fashion should be avoided. If it continues, the least it could do is to exclude food from the CPI basket.
It should take on board an idea mooted in the Economic Survey for 2023-2024. In the interregnum, the RBI should reduce the weightage of food inflation in CPI from the current 40% which is based on the Consumption Expenditure Survey (CES) of 2011-12 whereas the 2022-23 CES points towards a significant reduction.
(The writer is a policy analyst)