Indian year-on-year retail inflation having eased to 4.3% in May from 4.7% in April and 5.7% in March has given extrapolators the hope that our central target of 4% is within a few weeks’ reach. This, in turn, has cheered advocates of a policy pivot towards easy money after a rate-tightening cycle of 250 basis points by the Reserve Bank of India (RBI) over the past year or so. Wisdom, however, lies in taking RBI’s “pause” seriously. In other words, we must expect no premature action on the monetary front. As if to quell expectations, RBI Governor Shaktikanta Das said in a speech on Tuesday that the country’s disinflation process is likely to be “slow and protracted,” with 4% best viewed as a mark we will only hit over the medium-term, despite recent signs of softening. For the current fiscal year, RBI projects consumer price inflation at 5.1%. This figure not only captures the vagaries that prices are subject to, but justifies the need to stay in wait-and-watch mode as the lagging effects of past policy actions slowly come into play. Pivot hopefuls, however, must hold their horses for a more significant reason.
That inflation targeting works in an economy like ours had been a matter of debate before it was adopted in 2016, and while RBI failed to keep price escalation capped at 6% for three back-to-back quarters in 2022, the central bank has since had an odds-on chance to prove sceptics wrong by showing it can do the job assigned to it. In this context, the fact that Das outlined the rationale of going after our main cost-of-living index can be taken as a sign of confidence. “We recognize that the likelihood of financial turbulence would be high if there is no price stability,” the governor noted in his speech, “This reinforces our belief in the complementarity of monetary policy and financial stability in the long run.” By expressing RBI’s task this way, Das has drawn due attention to a basic aspect of the central bank’s mandate. For money to serve its prime purpose, its value must hold steady over long periods of time; and to the extent that a loss of purchasing power is inevitable, it should occur only along a path that’s both gradual and predictable. Once this is assured and RBI’s tools of inflation control are found to be effective, risk estimates of inflation warping nominal finances will drop, reducing the premium charged by lenders to cover that risk, while also helping borrowers assess their financial needs better and plan ahead properly. Eventually, sustained success on price stability will calm general price expectations and compress the cost of capital across the economy. Less volatile rates of interest would spell relatively stable operating conditions for businesses big and small, with financial shocks that much less likely. Achieving all this demands our patience while RBI finesses its approach.
What about the cause of spurring economic growth? With an expansion of 7.2% recorded in 2022-23 and above 6% expected this year, India’s post-pandemic performance has been satisfactory. So too, credit growth. At 6.5%, RBI’s chief policy rate is not too stiff in real terms (adjusted for projected inflation, i.e.). Sure, our economy needs to expand faster as we go along. For this, however, we should rely not on cheaper loans as a spur, but primarily on business investments that promise real returns to beat the inflation-adjusted cost of available funds. In a fast rising economy, calls to invest must spring from market opportunity—with a stable financial scenario as an enabler.
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Updated: 15 Jun 2023, 01:23 AM IST
