Inflation has peaked and is likely to stabilise going forward: RBI

For a one percentage point reduction in inflation, 1.5-2 percentage points of GDP have to be foregone

Inflation in the country will stabilise in the days to come, and the peak has been left behind in May-June, the Reserve Bank of India (RBI) said on Tuesday.

“So far, inflation is on track to staying within the trajectory envisaged and it is likely to stabilise during the rest of the year. In our view, this is a credible forward-looking mission statement for the path of inflation,” the central bank said in the State of the Economy Report - a part of its July bulletin - released on Tuesday.

The RBI, in its August 6 monetary policy, revised up its inflation projection for the current fiscal year to 5.7 per cent, from 5.1 per cent - “a correction for the deviation of the past”.

After recording a 6.3 per cent print in May and June, retail inflation cooled to 5.6 per cent in July.

The monetary policy committee (MPC) voted to give “growth a chance to claw its way back into the sunlight”, as measures to reduce inflation would also have dragged down prospects of economic growth.

“A reduction in the rate of inflation can only be achieved by a reduction in growth; an increase in growth is only possible by paying the price of an increase in inflation, always and everywhere,” the report, authored by MPC member and RBI Deputy Governor Michael Patra and his team, stated.

According to the report, the latest estimate for India suggested that “for a 1 percentage point reduction in the rate of inflation, 1.5-2 percentage points of gross domestic product (GDP) growth have to be foregone”.

The six-member MPC, therefore, voted unanimously to keep the policy repo rate unchanged at 4 per cent, and decided with 5:1 majority to keep the “accommodative” stance for as long as required.

The report defended the MPC’s decision, questioning the potential consequences of a dogged attack on the “supply shock-induced inflation” in a pandemic-ravaged economy.

What if, “as a consequence, economic activity wilts into depression? No amount of humility will wipe away the tears then”, it stated.

An India-focused MPC, therefore, did what was right for India, “emulating none, not emerging nor advanced peer”.

Growth in 2019-20 fell to 4 per cent, the lowest rate in the 2011-12-based GDP series. After two waves of the pandemic, growth “couldn’t conceivably be higher than in 2019-20”, the MPC observed.

However, the MPC remained mindful of its primary mandate of ensuring price stability. Given the sacrifice ratio concerning growth and inflation, the MPC adopted a glide path of graduated disinflation, aiming at spreading the output losses over a period, rather than going for decisive action that could kill the nascent recovery, cause large GDP losses, and set back the economy by several years because of policy actions, the report argued.

According to the RBI, the MPC anchored inflation around the target of 4 per cent during 2016-20, but the once-in-a-century pandemic “ratcheted up inflation all over the world, and India was not immune”.

The RBI’s inflation projections deviated from the actual because of “incomplete coverage and intensification of containment measures”, it said.

KEY OBSERVATIONS

• Fighting inflation would have dragged down growth
• MPC looked through inflation to give growth a chance
• MPC focused on India, emulating no other central bank
• Central bank digital currency to be introduced soon after meticulous planning

The current projection of 5.6 per cent was still a decline of 50 basis points from the preceding year’s average. In the end, the MPC’s endeavour was to become predictable, as it increased the credibility of the central bank, it said. The report also touched upon the need for the much-touted central bank digital currency (CBDC), stating, “there is a quiet confidence, within that its time is nigh”.

The CBDC, the RBI argued, was part of the RBI’s endeavour to provide a “safe, secure, and reliable payment and financial system, which will also exploit the country’s pole position in the domain of digital payments worldwide”.

CBDCs may not directly replace demand deposits held in banks, but will complement physical cash, and would compete with other online and offline payment methods. This will not only lend resilience to the payments ecosystem, but will also shun the risks associated with private digital currencies.

But, “the RBI is conscious that the CBDC has to be meticulously planned, designed, and tested”, it stated.

The recent enactment of amendments to the Deposit Insurance and Credit Guarantee Corporation was a “major step towards ameliorating depositor distress”, the central bank said.

The amendment allowed depositors to get back up to ~5 lakh of their deposits within 90 days if a bank fell under stress, and this augured well for consumer protection and the overall financial stability, the RBI report said.