RBI must explain why it is dithering on inflation control measures and protection of value of rupee

It seems RBI has moved away from its key function of controlling inflation and protecting value of money, not the stock market, which is mostly controlled by foreign investors and US fund managers

RBI (Photo Courtesy: PTI)
RBI (Photo Courtesy: PTI)

Nantoo Banerjee

Prices are bubbling up. Food, fuel and fertiliser costs are surging almost daily. Inflation seems to have got a free pass in India. The country’s wholesale price index, which tracks goods at factory gates, rose almost 13 percent from a year earlier in January. The gauge has recorded double-digit increases for 10 straight months.

The benchmark consumer price index, which also includes services, has breached the top of the Reserve Bank’s tolerance range of two to six percent annual gains. The central bank is eerily silent or remains constantly tolerant to rising inflation. It seems to have forgotten the universally-admitted principle that makes central banks play a crucial role in ensuring economic and financial stability by controlling inflation.

RBI’s long practiced low interest rate regime has benefited none — except probably overseas punters in the country’s stock market. India’s stock market is now bigger than Canada, Germany, and Saudi Arabia despite the fact that only around two percent of its population are known to invest in stocks.

A very small percentage of these investors in stocks make any big money. Markets occupy a lot of mind space and no wallet space for the rest of the population.

India’s stock market is mostly controlled by foreign investors and US fund managers. And, as such, it reacts mostly to overseas cues.

It seems that RBI has clearly moved away from its key function of controlling inflation and protecting the value of money, maybe to protect the stock market.

RBI’s monetary policy and framework have also failed to control its another key area of operation — maintaining a stable foreign exchange regime. The average exchange rate of Indian Rupee to US$ in 2013 was 56.57. In 2019 it was 70.4059. Lately, it reached a record low of Rs.77 against a Dollar.

This is despite the fact that there has been a continuous increase in the FDI inflow in recent years. The FDI inflow increased from USD 45.15 billion in 2014-15 to USD 81.97 billion in 2020-21.

In the absence of a proper inflation control regime on the part of the central bank, the real value or purchasing power of INR is constantly falling.

For inexplicable reasons, RBI continues to defend an indefensible pro-inflationary low-rate policy. The policy has not helped the growth of either industrial investment or new jobs. The Indian economy has been pushed to brace itself with further rise in inflation and unemployment rate.

Foreign portfolio investors (FPIs) are more cautious about the Indian market. FPIs don’t seem to be quite impressed with the financial performance of India’s listed companies. Their investment today is much less compared to net inflows of Rs 1.03 lakh crore in 2020.

Last year's quantum was lower than Rs 1.35 lakh crore invested in 2019. This year, FPIs have so far pulled out a net of Rs.1,14,856 crore from the Indian market amid inflation concerns and heightened geopolitical tensions.

FPIs reportedly sold domestic equities worth Rs.48,262 crore in the first four weeks of March, this year. The FPI exodus is largely due to possible impact of inflationary pressures on the Indian economy and foreign cues.

Historically, RBI has chosen a generally flexible exchange rate. Many countries do not fix the exchange rate. They still try to manage its level. That could involve a tradeoff with the objective of price stability.

Generally, a fully flexible exchange rate regime often supports an effective inflation targeting framework. Unfortunately, it is not being deeply noticed in India.

In popular democracies, the roles of the central bank are quite clearly explained. The most important of them, according to both the International Monetary Fund (IMF) and World Bank, refers to the conduct of monetary policy to achieve low and stable inflation.

Following the global financial crisis in 2008, central banks expanded their toolkits to manage volatile exchange rates as well. The Covid-19 pandemic made many central banks use an array of conventional and non-conventional tools to ease monetary policy, support liquidity in major financial markets and maintain the credit flow having eyes on inflation and exchange rate stability.

In fact, the IMF supports countries around the world by providing policy advice and technical assistance to these ends. In conducting an appropriate monetary policy, central banks use methods to influence the amount of money circulating in an economy, interest rates charged on loans, and the rate of inflation.

Inflation takes place when prices continue to rise, making the real value of a country’s currency continue to slide as it can’t buy as much and causing the loss of purchasing power of its people. Although to a limited extent, inflation provides a sign of economic growth over a mid-term period (one to three years) in a developing country, high and long-term inflation is always dangerous.

This type of inflation discourages investment and lending and wipes out people’s savings as it erodes the value of money. It also causes unemployment. This is exactly happening in India since 2018.

Central banks always work hard to keep inflation in check irrespective of its influence on stock markets. In the US, where more than 55 percent of adults invest in the stock market, its central bank, Federal Reserve, has never compromised on inflation control measures. The latest rate hike by the US Fed turned the spread between the yields of five-year and 30-year US Treasuries negative for the first time since 2006.

Last month, the US Fed raised interest rates for the first time since 2018, as the central bank struggled with soaring inflation, mainly because of the impact of the Ukraine war and coronavirus crisis. The Fed raised rates by a quarter percentage point. This is expected to be the first in a series of interest rate hikes planned for the coming months.

In a statement, the Fed said economic indicators and employment figures had “continued to strengthen”, but noted that inflation remained elevated and the invasion of Ukraine was not only “causing tremendous human and economic hardship” but was “likely to create additional upward pressure on inflation and weigh on economic activity” in the US. The Fed has two primary goals or a dual mandate. That’s to maximise employment and keep prices under control.

Unfortunately, India’s Reserve Bank is still non-committal on inflation control. The public savings are fast eroding their value. There is little sign of fresh large industrial investment as high prices have put demand under pressure. Unemployment is sharply rising. Under such circumstances, economic growth is bound to fail the target.

RBI must explain why it is dithering on inflation control measures and protection of the value of rupee.

(IPA Service)

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