India’s monetary chakravyuha and the calibrated output we need
Recent news from central banks around the world reveals a simple story: Measures to withdraw their extraordinary monetary stimulus have started.
The US Federal Reserve has indicated that it will soon begin to slow the pace of its balance sheet expansion. The European Central Bank has also said it will start slowing down its asset purchases in the last quarter of this year. Some smaller central banks in countries like Brazil, Iceland, Mexico, Chile, Russia and Hungary have raised interest rates. They were joined by Colombia, Jamaica, Peru, the Czech Republic, Paraguay and Kazakhstan. Norway recently became the first western economy to raise interest rates rather than absorb excess liquidity.
Some, like the central banks of Australia, New Zealand and Israel, have postponed their exit from monetary expansion due to unexpected new outbreaks of covid, but the direction in which they are heading is clear. China continues to be a big exception. Experience shows that central banks have an easier time embarking on monetary expansion in response to a crisis; on the other hand, the exits are delicate. Coordination between central banks is even more complicated, as economies recover from a shock at different speeds, as in the case of the North Atlantic financial crisis a decade ago as well as the covid shock at that time. era. Former Reserve Bank of India (RBI) Governor D. Subbarao once said that central banks are like Abhimanyu in chakravyuha – they know how to get into a system of monetary expansion but are less clear on where. way out.
It is against this background that the Indian Monetary Policy Committee (MPC) will meet this week to decide on its next move. Its six members will meet at a time when public debate has focused on the nature of an exit from monetary policy. There are straws in the wind. RBI has increased the rate at which it accepts offers in its floating rate reverse repurchase agreements. It has also kept the net liquidity effect of its G-Sec acquisition program to zero, selling and buying government bonds equally over the past two weeks.
At the August MPC meeting, Jayanth R. Verma disagreed with his MPC colleagues and pleaded in his dissent note for an accommodative monetary policy shift as well as an increase of the repo rate (which is technically outside the controlling MPC).
The next few days will show whether the majority opinion of the MPC has started to shift in this direction, although an outright hike in the repo rate is neither expected nor justified at this time. A growing number of private sector economists now anticipate the start of gradual policy normalization. A survey of 14 private sector economists by Business Standard’s Anup Roy shows a wide difference of opinion on which button India’s central bank will press first: a hike in reverse repo rates, a cut, or a lower. discontinuation of the G-Sec acquisition program, liquidity normalization, a timeline for an Indian variant of the taper, forward guidance on the normalization of monetary policy and longer term floating rate repurchase agreements.
RBI took the lead in the policy response to the economic downturn after the pandemic hit Indian shores. The size of its balance sheet is now nearly 53% larger than it was two years ago, dropping from ??41 trillion on September 27, 2019 at ??63 trillion on September 24, 2021. The RBI’s balance sheet now represents about 28% of India’s estimated nominal GDP for the full year ending March 2022. That’s nearly six percentage points of more than the pre-pandemic level, and at the higher end of the range over the past 35 years. It is important to remember that there are still six months left at the end of the current fiscal year, so it is entirely possible that further purchases of local bonds as well as foreign currency assets will bring the balance sheet of India’s central bank in uncharted territory. There is nothing sacred about the historical upper bound, but it is a useful marker at a time when inflation has been above the midpoint of the inflation target range for more than 20 months.
The first steps in India’s path to policy normalization will need to focus on eliminating some of the excess liquidity in the domestic money market, a shift in the monetary policy stance to accommodate to neutral, and the normalization of the RBI political corridor by an increase in the opposite direction. pension rate.
The last step would be a hike in the repo rate. This should only happen in 2022, especially since domestic demand from the private sector is still uncertain. In its September newsletter, RBI pointed out that the pace of monetary tightening in emerging markets depends on the situation on the ground. Commodity-exporting countries, which have improved their terms of trade and made good progress in immunization coverage, have generally been at the forefront of monetary tightening.
Niranjan Rajadhyaksha is a member of the Academic Council of the Meghnad Desai Academy of Economics
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