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Informist, Tuesday, Dec. 3, 2024

 

By Siddharth Upasani

 

NEW DELHI – Faced with a first-ever failure, the Reserve Bank of India's Monetary Policy Committee sharply increased interest rates starting May 2022, raising the policy repo rate by 250 basis points to 6.50% over the space of 10 months. But monetary policy works with a lag--which is why it needs to be forward looking--and the accelerated tightening could not prevent the central bank from failing to meet its inflation mandate in October 2022 after the CPI print for September confirmed average headline retail inflation had stayed above the 6% upper-bound of the target range for three consecutive quarters.

 

Unfortunately, interest rate hikes bring down both inflation and growth. The unexpectedly large decline in GDP growth in Jul-Sept to a seven-quarter low of 5.4% has brought elevated interest rates into focus, heaping pressure on the MPC to reduce the repo rate for the first time in four-and-a-half years on Friday, although most economists think the post-Budget meeting in February might be a more opportune time to do so.

 

That growth would moderate over the last couple of years was expected and even demanded by inflation-targeting policymakers. Sample the following from RBI Deputy Governor Michael Patra's statement in the minutes of the August meeting of the MPC: "Persistently rising prices are always and everywhere a reflection of too much demand chasing too less supply even if it is a supply shortfall that starts the price spiral. It is the remit of monetary policy to adjust demand conditions to the state of supply because this accumulation of price pressures threatens the outlook for both inflation and growth."

 

Two months after Patra made those comments, an RBI staff paper co-authored by the deputy governor estimated the MPC's 250 bps of repo rate hikes since May 2022 had "negatively contributed" to aggregate demand and headline inflation by 160 bps each till Jul-Sept. While the accompanying chart in the paper showed the impact of the rate hikes on aggregate demand seemed to have gradually moderated by Jul-Sept, has the growth rot been stemmed?

 

It is also possible last week's shock growth number was not all due to the monetary tightening of the last two-and-a-half years. In what seemed to be a warning of sorts, another RBI staff paper published just a few days before the Jul-Sept GDP data noted that indicators in India's national accounts statistics "observed a trough" in the second quarter of the financial year. Citing the central bank's various surveys, RBI economists pointed out that business assessment and order book assessment saw seasonal lows in the second quarter.

 

This is not to say that the slump in growth in Jul-Sept can be fully explained by seasonal factors and the RBI's past rate hikes having their full effect. If that was the case, growth should not have missed the central bank's forecast of 7.0% by such a wide margin. To be sure, forecasting is difficult at the best of times and the coronavirus pandemic "caused significant disruptions in economic activity, leading to unusual data patterns", as the second RBI staff paper said.

 

For much of the last couple of months, Governor Shaktikanta Das has argued that while India's growth picture is admittedly mixed, the positives outweigh the negatives. This, undoubtedly, was based on the central bank forecasting a GDP growth rate of 7.2% for 2024-25 (Apr-Mar). On Friday, this number will have to be revised downwards purely because the maths does not support such a figure any more, unless the RBI sees a remarkably strong turnaround in the second half of the year. But whether Das and his deputies will admit the central bank erred in its assessment or if the slowdown witnessed in Jul-Sept is the desired product of its policies is the pertinent question.  End

 

Edited by Saji George Titus

 

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