Self-recovering economy gets a gentle RBI nod!

Martin Luther King Jr. “But I know, somehow, that only when it is dark enough can you see the stars. Keep moving. Let nothing slow you up. Move on …..”

The above statement was the backbone of credit policy announced by RBI Governor Mr Das on 6th August. Completely in line with the market expectations of no changes in the major numbers for the 7th time, that’s about 14 months since May 22, 2020, when the interest rates were cut to historical lows. The keywords in his address were ‘nurture’ ‘nascent and hesitant’ ‘see through’ and ‘accommodative’. No marks for guessing that these were for the economy that is recovering from the pandemic hit.

Inflation: Rising inflation was the most weighed number while discussing and subsequently announcing the policy. The inflation numbers are now estimated to 5.7% from an earlier 5.1% for FY22. This is a considerable 12% increase, but this has been seen through by the Monetary Policy Committee (MPC); rightly, in favor of growth. The spike in the Headline Inflation was largely due to the increase in food and fuel prices of the bucket. The Core Inflation has seen a moderation from its highs.

Headline Inflation is the change in the entire basket of products mostly indicated by CPI(Consumer Price Index). Core Inflation is calculated after removing ‘Food and Fuel components’ from the Headline Inflation as food and fuel prices are volatile in both directions and may not show the true picture. In developed economies, these constitute 10-15% of the total basket. In India, the food component constitutes 45.8% of the total Headline Inflation and it's this component that has moved inflation so much, riding on the prices of at-pump-fuel prices that have sky-rocketed recently. Given the general situation of the economy and jobs, I consider the food-fuel basket to me of most prime importance and would hope this be curbed but by managing the supplies and taxes.

Now, ignoring this inflation, RBI has decided to keep the Repo(@4%) and Reverse Repo rates(@3.35%) the same as earlier, to maintain enough liquidity in the market that is conducive to growth and jobs creation in the economy, which I believe is a great move. How does it work? Easy money in the market prompts entrepreneurs to take risks and start new businesses and/or grow existing ones thus creating new jobs/ increasing salary/ corporate profits, leading to an increase in demand for essential, elective and luxury products.

As they say in India; the faster Laxmi travels the more it grows!

Now, what’s a Repurchase Option Agreement (Repo) rate. Simply put it’s the rate at which commercial banks can borrow from RBI to further lend to their customers. And the Reverse Repurchase Option Agreement (Reverse Repo) rate is the interest that the banks earn for keeping their excess money with RBI. Both these factors have a direct impact on the flow of money(liquidity) in the economy. This is done by dealings in RBI-approved securities such as Government of India and State Government Securities, Treasury Bills, FI Bonds, Corporate Bonds, PSU Bonds, etc.

Now you may ask, why to bother about inflation & why not let the economy grow on the back of high liquidity. One, inflation fuelled growth is not real GDP growth and that does not lead to the creation of assets and jobs. Two, when unchecked it leads to an arbitrary valuation of the current assets and depletion in the real currency value and no one wants to deal with such erratic currency. Three, people lose faith in the monetary framework of the economy. Hence there is a severe loss of trust and the nation has to pay a much high premium to attract investments and demand leading to external demand waning out, affecting the prosperity of the nation in this highly globalized world. So, a delicate balance is to be maintained.

RBI also believes that the current inflation situation is the adjustment in supply-demand in the economy after an unprecedented event and things are likely to improve, albeit marginally, as the recovery stabilizes and the Kharif yield hits the market in Q3.

The Governor also applauds the businesses for adopting innovative and stricter working models that will go a long way in helping the corporates long after the recovery has happened making them more profitable. My concern is that a major part of the corporate savings may have come on human cost and one must relook that trend if the economy has to see a long, sustained and satisfying recovery for a largely young,aspirational and highly educated population.

Further, RBI has kept the real GDP growth target as the same by IMF at 9.5% for FY22. Most of this growth(21.4%) is going to come in Q1 and then taper to reason. For FY23, the growth rate is expected to be at 17.2%. Phewww!

So, all in all, no fireworks in the monetary announcements of today as a nascent, delicate and pre-mature recovery is on it’s way and there is no point in shaking a self-stabilizing boat. We have seen in the past that the RBI has managed many a crisis with high diligence and has kept the Indian economy safer than the rest of the world. Use of the term ‘hope’ is highly appropriate here and it’s in this hope of recovery only, all the fiscal and monetary decisions are being taken by the government and its arms.

In the end, do you think a more liberal monetary stance will help the economy better?

Why or why not?

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