rbi policy meet: What MPC and Shaktikanta Das need to remember as they ponder over their options

Budget FY2023 has signalled GoI’s willingness to spend big on infrastructure, in readiness for India’s ‘amrit kaal’. After months of fiscal hesitancy, the government seems to have realised it needs to lead from the front, rather than lean on RBI’s shoulders. It has donned the mantle of growth. The glide path to fiscal rectitude is to be gradual, rather than abrupt, and capex is set to rise 35% this year to ₹7.5 lakh crore.

All this is good news. Unfortunately, the foundation for this ambitious government spending rests on a record level of government borrowing. Government borrowing has been pegged at ₹14.95 lakh crore, up from ₹12.5 lakh crore estimated in the last year’s Budget. After adjusting for small savings and other liabilities, this leaves GoI and its debt manager, RBI, with the task of raising ₹1.6 lakh crore from the market, up from ₹8.7 lakh crore last year, more than ₹22,000 crore every week. An uphill task in a year when RBI should, in keeping with central banks the world over, begin withdrawing the extraordinary accommodation extended ever since the Covid pandemic broke out in early 2020.

Remember, every country has essentially two policy levers to ensure sustained economic growth – fiscal policy, which is the government’s domain, and monetary policy, the central bank’s. The former is driven by elected governments, subject to the whims of electoral politics, while monetary policy is driven by professional central bankers and an independent central bank (in spirit, if not on paper). Consequently, central banks are often entrusted, and expected, to take unpopular decisions – to take the punch bowl away just when the party starts.

Back on Track

In practice, Covid resulted in a blurring of the lines and brought governments and central banks together to act as one in a bid to save the economy from the impact of the pandemic. But now as the world economy recovers, governments and central banks are reverting to their traditional roles – governments focused on growth and central banks focused on inflation fighting.

We’re seeing this in the US where the US Federal Reserve has not only announced its decision to roll back its earlier accommodation, but is now set to do this faster than anticipated. Fed chair Jerome Powell is emphatic that the days of easy money are over. With US inflation at 7% in December 2021, Powell and Joe Biden are on the same page. Inflation is their first priority.

Contrast this with India. Even as GoI lays proud claim to a V-shaped recovery, it is seemingly loath to acknowledge the risk posed by rising inflation. Instead, it seems to take comfort from the fact that the December inflation number of 5.6% is within RBI’s inflation band, ignoring both the high wholesale price inflation of 14.2%, high and rising global oil prices, as well as geopolitical tensions that are bound to raise it further, not to mention the inflationary impact of its large borrowing programme.

The Lone Warrior

Where does this leave the MPC? Remember, GoI’s spending plans require support from RBI. Remember also that all the heavy lifting to date has been done by RBI, often beyond what the MPC, perhaps, intended. The result has been months of high inflation. We could well say of RBI what Stephen Roach said of the US Fed, ‘It is now passe to warn that the Fed is behind the curve. It is now so far behind that it can’t even see the curve.’

In such a scenario, should RBI be a lone warrior among central banks and keep monetary policy accommodative, even though such a policy is almost certain to aggravate inflationary pressures? Or should it take courage in its hands and step back?

Sure, that does leave the question of how the deficit will be financed unanswered. We could, of course, turn to easy come-easy go overseas investors by pursuing the soft option of inclusion in the bond index. But that would be a case of short-term gain for long-term pain. Today, if we are more confident of being less vulnerable to any taper tantrum in the fallout of Fed tightening, it is not only because of our higher reserves, but also because most of our debt is domestically held. Do we wish to lose that advantage? No. Aggressive disinvestment is the only answer.

Switches – swapping securities maturing near-term for those maturing later – and open market operations could help. But ultimately it will have to be a trade-off between supporting government borrowing (distorting market signals) and being true to RBI’s swadharma – price control. ‘Credibility’, as Raghuram Rajan recently remarked, ‘takes years to earn.’ But it’s also easy to lose. As the MPC and Shaktikanta Das ponder over the options before them, they would do well to remember that today it is RBI’s to lose.