It’s too risky to revert so slowly to policy as usual

A recency bias tends to attend discussions of policy rates of interest. Especially salient in recent days has been word from the US Federal Reserve that it may moderate its rate escalation a bit, having gone in for a steep incline this year in response to flaring US prices. Since tighter money operates with a long lag as it cramps credit and dampens demand, the Fed may have good reason to decelerate its tightening. To the extent that a rate differential with America impacts our capital inflows (and rupee), that would hold some relevance for RBI’s monetary policy panel. But we cannot assume similar inflation dynamics in India. The lag with which rate tweaks take effect is usually longer here, the job scenario hardly matters, and we have a jumble of rigidities that can make it harder to get a handle not just on prices stiffened by supply snarls, but also on core price instability (not counting fuel and food, i.e.). If price control is the de jure and de facto challenge, then RBI must go chiefly by domestic inflation concerns.

While bankers have aired expectations of a 35-basis-points hike in RBI’s repo rate after three successive 50-basis-point hikes, with a manufacturing slump cited alongside its within-range inflation forecast for early 2023-24 to justify this, a premature let-up would risk going too slow on an easy-money reversal. For one, RBI’s inflation outlook has been unreliable. For another, a repo rate upped to 6.25%, say, would only be slightly positive in real terms even if we can count on RBI’s projection of an inflation dip next year. Even by a flexible interpretation of the Taylor Rule, this would still spell a policy meant for easy lending. Neutrality would call for a rate that’s clearly above trend inflation, its bar set sufficiently high for real returns on investment to attract funds, but without letting overly risky speculation run rife and dubious asset bubbles inflate. Crucially, we must not let loose fiscal and monetary policy snuff out the hope of a low-inflation economy. Let covid not be a pretext that makes space for cynicism over public debt piled up only to be inflated away. We need an orderly return to policy normalcy.