Saturday, May 18, 2024

Everybody appears to love a good bout of high inflation

It is often asked whether monetary policy is a public good. Looking at the tenor of the monetary policy emerging from the Reserve Bank of India (RBI), it might even be legitimate to ask if inflation is also a public good. The first monetary policy for fiscal 2023-24 has hit the pause button on its 11-month drive to increase benchmark interest rates and control inflation. It is quite possible that some level of familiarity with higher inflation has seeped into the national consciousness because inflation has steadfastly stayed above RBI’s legislative mandate for over a year now; the same level of tolerance, however, seems to be missing for higher interest rates. Governor Shaktikanta Das has, however, insisted that it’s only a pause and not a pivot, thereby ensuring that policy expectations do not race ahead of themselves.

RBI’s decision to suspend the 11-month spree of rate increases was certainly among the list of probable outcomes considered by analysts, though the street consensus converged around a 25-basis-points hike. Taking its statement at face value, the logic behind the pause and its timing seems to make sense. In many other ways, though, something doesn’t quite add up; the decision to flip the policy design to privilege growth over inflation control—even if temporarily—is at odds with its overtly bullish outlook for growth.

What stands out is RBI’s contrarian stance against numerous forecasts about the likelihood of a growth slowdown during the next 12 months. The central bank’s 6.5% growth estimate for 2023-24 looks bullish when compared with forecasts from the World Bank and other multilateral agencies; even rating agency Crisil expects this fiscal year’s growth to clock in at only 6%. In fact, RBI seems to have not only disregarded all slowdown projections, but also appears to be outdoing the finance ministry. Compared with the Budget’s estimated 10.5% nominal growth projection for 2023-24, RBI expects the year to end with 11.7% growth.

To be fair, though, the Budget estimate for 2023-24 is based on the first advance estimates (FAE) of gross domestic product (GDP) for 2022-23, released in January’s first week, while RBI’s is based on the second advance estimate (SAE), which was released in end-February. Much water would have flowed down the Gangetic plain between the FAE and 3 April when the monetary policy committee began its deliberations. But the devil lies in the absolute numbers. RBI’s absolute GDP for 2023-24 (based on 11.7% nominal growth forecast) is marginally higher than the Budget estimate, despite a significantly higher growth rate, because it is predicated on a small base. The SAE for 2022-23 GDP is actually lower than FAE by over 1 trillion. And so, while all indicators, including official estimates, were flashing slowing growth, it is mystifying that RBI—with so much additional data at its disposal—has chosen to diverge from the emerging consensus. Ordinarily, a central bank sensing stellar growth potential amid sticky inflation may have acted differently.

Analysts will tend to view RBI’s decision through the prism of the political economy. There is no escaping this reality, especially since the institution’s autonomy has increasingly been under question over the past few years. This trend is also manifest in the literature emerging from the central bank. Given this reality, it is likely that the pause will be viewed in the shadow of the approaching Karnataka state elections next month.

Add to this mix the curious role and political reality of India’s business-political alliance. The leadership of India’s three leading chambers of commerce—Sanjiv Bajaj from the Confederation of Indian Industry, Subhrakant Panda from Ficci and Ajay Singh from Assocham—lobbied to stay RBI’s hand from raising rates. And they seemed to have got what they wanted. What appears anomalous is the rate transmission data provided by RBI. Banks seem to have passed on a big chunk of the 250-basis points cumulative rate hike of the past 11 months to retail borrowers and agricultural credit takers, while rate hikes for large businesses have been lower.

This also foregrounds former RBI deputy governor Viral Acharya’s paper at a recent Brookings Institute seminar in which he argues that concentration of market power in the top five Indian conglomerates has led to unfettered mark-ups and persisting core inflation. “Analysts argue that goods inflation in India is in fact likely to persist as margins of manufacturers in India are substantially high due to, one, their protection via tariffs, and two, their market power from rising concentration.”

On balance, it would seem that there is greater tolerance on Mint Street for higher inflation than for higher interest rates, even though the private sector failed to take advantage of historically low interest rates over the past few years. It also revives the decades-old debate about whether to make inflation an instrument of development policy over inflation control as a policy objective. Moderate inflation is perceived to have some benefits and, in the Indian context, the corporate sector stands to gain the most.

A higher acceptance of moderate inflation also raises questions about the efficacy of a flexible inflation targeting policy framework, especially since RBI has been aiming for an inflation level that is far removed from its mandated target: 5.2% for 2023-24 against the legislated level of 4%. So, with due apologies to P Sainath, this does beg the question: Who exactly loves a good bout of inflation?

Rajrishi Singhal is a policy consultant and a senior journalist. His Twitter handle is @rajrishisinghal.

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