QUESTION: Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments.
Topic- ALERT AMID UNCERTAINTY
- Monetary Policy of RBI
WHY IN NEWS ?
- The third review of the monetary policy by the RBI since the COVID-19 pandemic spread in the country.
MONETARY POLICY COMMITTEE (MPC):
- The RBI Act, 1934 (RBI Act) was amended by the Finance Act, 2016, to provide for a statutory and institutionalized framework for an MPC, for maintaining price stability, while keeping in mind the objective of growth.
- The MPC is entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level.
- The meetings of the MPC are held at least 4 times a year and it publishes its decisions after each such meeting.
- As per the provisions of the RBI Act, out of the six members of the committee, three members are from the RBI and the other three Members of MPC are appointed by the Central Government.
- Governor of the RBI is ex officio Chairman of the committee.
WHAT IS MONETARY POLICY ?
- Monetary policy is the process by which the RBI controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability.
- RBI reviews its monetary policy every two months.
- The RBI implements the monetary policy through open market operations, bank rate policy, CRR, SLR, reserve system, credit control policy, moral persuasion etc.
- Using any of these instruments will lead to changes in the interest rate, or the money supply in the economy.
- Increasing money supply and reducing interest rates indicate an expansionary monetary policy. The reverse of this is a contractionary monetary policy
How interest rates dominate?
- To contain inflation, a country’s central bank typically increases the interest rates in the economy.
- By doing so, it incentivizes people to spend less and save more because saving becomes more profitable as interest rates go up.
- As more and more people choose to save, money is sucked out of the market and inflation rate moderates.
LINK BETWEEN GROWTH INFLATION AND INTEREST RATES :
- In a fast-growing economy, incomes go up quickly and more and more people have the money to buy the existing bunch of goods.
- As more and more money chases the existing set of goods, prices of such goods rise. In other words, inflation (which is nothing but the rate of increase in prices) increases.
- To contain inflation, a country’s central bank typically increases the interest rates in the economy. By doing so, it incentivises people to spend less and save more because saving becomes more profitable as interest rates go up.
- However, when growth contracts, people’s incomes hit. As a result, less and less money is chasing the same quantity of goods. This results in either the inflation rate decelerating or it actually contracts (also called deflation).
- In such situations, a central bank decreases interest rates so as to incentivise spending and by that route boost economic activity in the economy.
- In the current Monetary Policy, RBI has not raised the interest rates even when retail inflation is high because RBI is facing an odd situation at present: GDP is contracting even as inflation is rising.
Why has RBI not raised interest rates this quarter?
- RBI is facing an odd situation at present: GDP is contracting even as inflation is rising.
- This is happening because the pandemic has reduced demand, on the one hand, and disrupted supply on the other.
- As a result, both things are happening — falling growth and rising inflation.
- It is true that for containing inflation, RBI should raise interest rates.
- And under normal circumstances, it would have done just that. But raising interest rates at this stage would be catastrophic for India’s GDP growth.
- Inflation measures the average price change in a basket of commodities and services over time.
- Inflation is indicative of the decrease in the purchasing power of a unit of a country’s currency. This could ultimately lead to a deceleration in economic growth.
- However, a moderate level of inflation is required in the economy to ensure that production is promoted.
- In India, the Ministry of Statistics and Programme Implementation measures inflation.
- In India, inflation is primarily measured by two main indices — WPI (Wholesale Price Index) and CPI (Consumer Price Index) which measure wholesale and retail-level price changes, respectively.
- The CPI calculates the difference in the price of commodities and services such as food, medical care, education, electronics etc, which Indian consumers buy for use.
- The CPI has five sub-groups including food and beverages, fuel and light, housing and clothing, bedding and footwear.
HEADLINE INFLATION VS CORE INFLATION:
- Headline Inflation is the measure of total inflation within an economy. It includes price rise in food, fuel and all other commodities.
- The inflation rate expressed in Wholesale Price Index (WPI) usually denotes the headline inflation. Though Consumer Price Index (CPI) values are often higher, WPI values traditionally make headlines.
CORE INFLATION(Underline Inflation or Non-food Inflation) :
- Core inflation is also a term used to denote the extend of inflation in an economy. But Core inflation does not consider the inflation in food and fuel. This is a concept derived from headline inflation. There is no index for direct measurement of core inflation and now it is measured by excluding food and fuel items from Wholesale Price Index (WPI) or Consumer Price Index (CPI)
- The picture on prices is clouded by many uncertainties. The provisional June CPI inflation reading of 6.1% had edged over the upper bound of the mandated medium-term goal of 4% plus/minus 2%.
- A spike in food prices as well as cost push pressures from higher transport fuel and raw material prices were combining to obscure(unclear) the inflation outlook.
- Vowing to ensure that the policy stance remains ‘accommodative’ for as long as needed to revive growth, Governor Shaktikanta Das emphasised that the RBI was ready to act on rates once a durable reduction in inflation was sighted.
- For now, however, the projections remain less than encouraging.
- The latest round of households’ expectations of price gains in an RBI survey shows that consumers expect inflation to remain elevated in the near term — a finding that the RBI’s assessment broadly backs
- The forecast on the economy is worrisome.
- The RBI expects the rural economy to turn in a robust recovery on the back of a strong showing by agriculture. However, deterioration in consumer sentiment in the RBI’s July survey undermines the prospects for a more broad-based revival in domestic demand.
- External demand faces headwinds from a world economy in recession and as global trade shrinks.
STATUS OF ECONOMY, ACCORDING TO RBI :
- Mutual funds have stabilised since the Franklin Templeton episode
- Supply chain disruptions persist; inflation pressures evident across segments
- Economic activity had started to recover, but surge in infection has forced imposition of lockdowns
- Real GDP growth is estimated to be negative for 2020-21
- Recovery in rural economy expected to be robust
- Global economic activity has remained fragile
GROWTH PROJECTIONS :
- Economic activity had started to recover from the lows of April-May 2020 following the uneven reopening of some parts of the country in June 2020.
- However, fresh Covid-19 infections have forced renewed lockdowns in several cities and states, and economic indicators have levelled off.
- The recovery in the rural economy is expected to be robust, buoyed by the progress in kharif sowing.
- Manufacturing firms responding to the RBI’s industrial outlook survey expect domestic demand to recover gradually from the second quarter of 2020-21 and sustain through the first quarter of 2021-22.
- For 2020-21 as a whole, real Gross Domestic Product (GDP) growth is expected to be negative. Early containment of the pandemic may improve the outlook.
- The onus now is on Governor Das to ensure that the stability of the financial sector safeguarded even as loan terms are reset to protect otherwise viable businesses.
- Any harm to financial stability risks – undermining the economy as a whole.