Don’t miss the latest developments in business and finance.

Shades of status quo

Reversal of interest rate cut should have been avoided

Shades of status quo
Business Standard Editorial Comment New Delhi
3 min read Last Updated : Apr 01 2021 | 11:28 PM IST
The Union government did well to retain the inflation target under the flexible inflation targeting framework. Consequently, the Reserve Bank of India (RBI) will have to maintain the inflation rate based on the consumer price index at 4 per cent with a tolerance band of 2 percentage points on either side till 2025-26. Several commentators had suggested increasing the upper tolerance limit to give the central bank more flexibility in dealing with economic shocks, such as the one associated with the pandemic. Although such a move would have given the monetary policy committee (MPC) more space in the short run, it could have affected market confidence and pushed up inflation expectations. This could have potentially pushed up inflation more enduringly with higher longer-term costs. Besides, as a recent study by RBI economists showed, the target has worked well for the Indian economy. Not only has the pace of price increase moderated since the adoption of the flexible inflation-targeting framework but inflation volatility also came down. Thus, it made sense to continue with the inflation target, particularly in the given uncertain global macroeconomic environment.

After the status quo on the target, the MPC is also expected to leave the policy rate unchanged in its first policy review of the financial year next week. A rapid rise in the number of Covid-19 cases and restrictions on movements in different parts of the country have increased risks for economic recovery. Core sector output in February, for instance, contracted by 4.6 per cent. Although the decline came on the back of a higher base and the fact that February this year had one day fewer than last year, the number is disappointing. On the inflation front, while the headline rate came down in recent months, core inflation at about 6 per cent is worrying. The rate-setting committee would do well to explain how it intends to deal with it as core inflation could push up the headline rate. The central bank would be somewhat relieved as the latest numbers suggest that the fiscal deficit of the Union government for 2020-21 is likely to be lower than the revised estimates, though it may not have a significant impact on bond yields as overall borrowing will remain at a higher level. The government has a gross borrowing target of Rs 12.05 trillion for 2021-22.

While the government did well to maintain the status quo on the inflation target, the same cannot be said regarding its decision on administered interest rates for small savings instruments. The government on Wednesday reduced interest rates on small savings instruments. However, Finance Minister Nirmala Sitharaman on Thursday termed the decision an “oversight” and announced a withdrawal. This is unfortunate because of a variety of reasons. For instance, it reflected poorly on the government’s decision-making process. Further, rates on small savings instruments must be aligned with prevailing market interest rates. Higher administered interest rates on small savings instruments are often seen as a major barrier to monetary policy transmission. Banks are reluctant to cut deposit rates beyond a point because of the fear of losing deposits to small savings instruments. Paying a premium over market rates also affects government finances because of its dependence on such instruments to fund the fiscal deficit. Thus, a reversal should have been avoided.

 

Topics :Reserve Bank of IndiaNirmala SitharamanCoronavirusInflationInterest rate cutmonetary policy committeeMPCIndian EconomyCore Sectorsmall savings schemes

Next Story