The MPC kept repo rate unchanged (4:2 majority) and persisted with the neutral stance, while the RBI cut CRR by 50 bps which was beginning to emerge as the majority expectation post recent liquidity tightness. Forecast changes are summarized below:
Before we turn to the policy nuances and our expectations, we visit briefly the broader framework for macro policy in light of developments since the Covid crisis.
A Framework Discussion
It is well understood that developing markets have tighter thresholds of macro stability parameters than their developed market counterparts. This was in evidence during the Covid response where countries like India had to have a much more nuanced fiscal and monetary response as compared to the US which, admittedly, was the other extreme. Of course, this had also to do with the diagnosis of the sustained economic impact and the extent to which the respective economy was willing to borrow from future generations. The result, however, was that while US was able to recoup all cumulative output lost versus previous trend growth (and then some more), India had to be able to post years of above previous trend growth in order to be able to do so. Thus, a post Covid challenge for fiscal and monetary authorities has been to be able to nurture growth expansion for longer via judicious macro policy that sustains financial stability. One must note that Indian policy makers have been remarkably adept at this. Thus, RBI’s proactive monetary tightening, alongside auto-expiry of Covid liquidity measures, ensured that repo rate could peak at a relatively modest 6.5%. Alongside, regulatory measures have pre-empted any meaningful buildup of financial imbalances. On its part, the government moved to re-orient spending towards capex and consolidate fiscal deficit once the crisis was over.
An additional challenge imposed, however, has been from the continued US exceptionalism. At first the very aggressive Covid fiscal and monetary response led to high US rates and stronger dollar. However, these have largely sustained owing to limited fiscal compression there, accompanied with a productivity and labor supply boost. This set-up naturally curbs the degrees of freedom available for countries like India in the near term, even as our growing resilience will ensure that this is less so over the medium term. Thus, greater prudence is naturally warranted to ensure ongoing financial stability which in turn allows for a consistent runway for growth. At the same time, the sensitivity to a growth slowdown has to be greater given that there is still a cumulative output loss to fill which in turn impacts the economy’s ability to fully absorb the additions to labor supply. As an aside, this same dynamic is probably ensuring that high food inflation has so far not seeped into core. It also means that one cannot worry about demand inflation too much.
Monetary Policy Assessment Under The Above Framework
The framework above throws up three takeaways:
1. Prudent expansion and then normalization of fiscal and monetary policy has allowed countries like India to sustain the post pandemic expansion for longer.
2. The continued US exceptionalism has limited degrees of freedom for policy in the near term.
3. Optimization is nevertheless required within this constraint given the need to fill the cumulative ‘output deficit’.