RBI’s quandary: Boost growth or arrest inflation

Udit Misra
Reserve Bank of India Governor Shaktikanta Das. (Express Photo: Prashant Nadkar)

On Wednesday, official data showed that retail inflation in the country for October was 4.6%. This is not only the highest retail inflation in 16 months but also crucially above the RBI’s target level of 4%. Ordinarily, this would lead to a straightforward response from the RBI — it would be expected to raise interest rates to cool down the rising tide of prices. But, at present, the RBI faces a tougher problem.

What is the RBI’s current quandary?

Here’s a combination no central banker wants to face: slowing economic growth and rising inflation. That’s because the typical monetary policy measures — such as cutting interest rates — that a central bank uses to boost economic growth tend to fuel inflation.

What are the economic growth concerns?

India’s economic growth rate has steadily decelerated since 2017-18. The 5% growth in the first quarter (April to June) of the current financial year was the slowest Indian grew in the past 6 years.

Most leading indicators suggest that the growth in the second quarter (July to September) would be even lower — closer to 4.5%. Indeed, from the high estimates of 8% to 8.5% growth for the full year that the government’s Budget assumed as late as July, most forecasters now peg the full-year growth to fall below 5%. The prognosis is poor — growth is likely to stay just around the 6% mark in the next financial year (that is, 2020-21).

The deceleration in economic growth and it staying well below the 8% mark will increasingly imply fewer jobs, lower incomes, rise in poverty and adverse health outcomes for the worst off. Most estimates suggest that total employment in India fell in absolute numbers between 2012 and 2018. If growth doesn’t recover fast this issue of millions of unemployed youth at a time when India is witnessing a demographic bulge in its young population could potentially create social unrest.

Explained

Food inflation likely to be on rise till March

The surge in the headline inflation print was widely expected, given the spike in prices of vegetables, meat, fish and eggs, due to disruption in transportation caused by excessive rains. Food price inflation is likely to rise further at least till March 2020, mainly due to food price deflation till February 2019 and low inflation in March 2019. The CPI data also reflects a slump in core inflation, indicating sluggishness in demand. With rising inflation rate and a lower growth scenario, RBI will have to do a balancing act at its next meeting.

But hasn’t the RBI been cutting interest rates to boost growth?

Indeed, it has. Between February and October, the Monetary Policy Committee (MPC) of the RBI repeatedly cut rates by 135 basis points to boost economic growth and spur consumer spending, although with limited impact.

But what allowed the RBI to cut rates all along this year was the low retail inflation. That provided the policy space for the RBI to cut interest rates without worrying too much about stoking inflation.

With the October inflation breaching RBI’s target level of 4% — and most estimates suggest that retail inflation will stay above this mark till March (that is, the end of the financial year) — that policy space has narrowed, if not closed altogether.

Members of the MPC will have to reconsider and recalibrate how they handle the concerns of boosting growth — RBI has been explicitly gunning for this — and arresting inflation, which it is mandated by law to maintain at 4% ( plus or minus 2%).

Is there a way out?

Possibly, yes.

Most of the impetus to headline inflation is coming from food inflation. In particular, it is the prices of vegetables, pulses and meat and fish that have seen a massive upsurge. In fact, core inflation — that is inflation that disregards the prices of food and fuel — has decelerated, thanks to the slowdown in overall economic activity.

This means that there could be other policies that could alleviate the supply-demand mismatch that is showing up in higher prices. Of course, monetary policy is not the only way to address either growth or inflation. The current situation would throw the spotlight back at the government to do whatever it can to ensure that inflation comes down without the RBI being forced to raise rates — a move that will hurt growth revival.

Don't miss from Explained: What bringing Chief Justice of India’s office under RTI means