Signalling optimism

Context:

Latest review:

The Monetary Policy Committee (MPC) has voted to keep policy interest rates unchanged and has stated that it would continue with the accommodative stance at least through the end of the current financial year.
An accommodative stance means that the central bank will cut rates to inject money into the financial system whenever needed. This is often employed to expand the overall money supply to boost the economy when growth is slowing.
This move seems to be indicative of the MPC’s priority to revive economic growth on a durable basis and mitigate the impact of COVID-19 on the economy.
This is a welcome move given that the economy needs all the support it can get to recover from its 23.9% estimated contraction of the first quarter.
This move would help maintain liquidity and stability in the financial markets, at a time when the resources-strapped governments are expected to resort to substantially higher levels of borrowing to meet their spending needs.

Issues:

Side lining inflation control

The latest monetary policy review seems to be indicative of the sidelining of inflation concerns. The MPC seems to have tilted away from its inflation-targeting mandate.
The MPC considers that the reason for the current inflation being above the tolerance band is mainly due to supply shocks and it expects these shocks to dissipate as the economy unlocks and supply chains are restored.
Even the RBI Governor has repeatedly stated that the current ‘inflation hump’ is a transient phenomenon.

Doubts over inflation estimates:

The inflation assumptions seem inaccurate given that it estimates the CPI inflation to sharply ease from 6.8% in Q2 to 5.4% in Q3 and 4.5% in Q4, given the persistence of supply bottlenecks, cost-push pressures from higher taxes on transport fuels and the possibility of food-price inflation.
Economists have suggested that through this move the MPC has sought to talk up confidence ignoring the risks of inflation.

Risk of forward looking guidance:

The MPC has projected that it would stick with the accommodative stance “at least during the current financial year and into the next financial year”. This forward-looking guidance would leave the MPC with little near-term leeway to tame price pressures.
This could hamper the MPC’s ability to take measures to support the ‘emerging impulses’ and help the economic revival.

Source: TH