How do you see the macroeconomic scenario both globally and in India today?
Globally, IMF says it is the deepest and most extensive recession since the Great Depression of the 1930s and IMF also says that the recovery out of this crisis is going to be long, uneven and uncertain. One thing we have to note is that this crisis is different from the 2008 financial crisis because the 2008 crisis originated in the financial sector, the solution lay in the financial sector, the solution was in the hands of the governments and central banks and they knew that financial stability will be restored if confidence in the financial system is restored. Rest everything else will fall in place.
On the other hand, this crisis is because of a cause outside of the economic system, outside of the financial system and the solution has to come from science. All that the governments and central banks can do meanwhile is hold fort. So this crisis is different from the 2008 crisis because of the level and depth of uncertainty and, of course, one important consequence of this crisis globally is going to be the accentuation of inequalities within and across countries.
After the Global Financial crisis in 2008, when you were the governor, RBI was quick to respond and rapidly eased liquidity. This time around too the RBI has responded to the slowdown caused by the pandemic. But there is excess liquidity of close to Rs 8 lakh crore, high inflation, acid bubbles in the stock and commodity markets. Is there a sense that the lessons of 2008 have not been learnt by RBI?
I do not think I will agree with your surmise. It is true that one of the important lessons of the 2008 crisis is that as much as you eased during the crisis in order to reverse and help recover the economy, it is also very important to exit out of the expansionary policies in good time. Today in response to this crisis, the RBI has cut policy rates. Policy rates today are negative in real terms and they have injected an extraordinary amount of liquidity, which is the banking system surplus that is flowing into the reverse repo window of the RBI on a regular basis.
But we know RBI has done this in order to infuse confidence in the economy, in order to preserve financial stability and in order to support recovery. At the same time, we are aware of the concerns on the inflation front. Inflation has been above RBI’s target for the last several months and it is expected to be above RBI’s target for next several months. The extraordinary easing of the RBI is militating against its inflation management responsibility.
There are concerns that inflation might get generalised and turn into core inflation too soon unless RBI withdraws in good time. I am sure RBI is quite conscious of that and I do want to say that withdrawing from extraordinary easing driven by the crisis is very important. The timing, sequencing and the forward guidance that is given for it, is an important lesson we have learnt from the 2008 crisis.
You have talked about timing the exit and Dr Shaktikanta Das has also said that premature withdrawal of liquidity will hurt growth. This is a possibility at all times. So what should the RBI do? If you have to relive GFC days, would you have withdrawn the easy liquidity conditions a little earlier?
What is premature withdrawal is not clear in real time. It is always apparent in hindsight. In real time, policymakers — particularly governments and central banks — are operating within the universe of knowledge available to them and making judgements on that basis. There is a risk that policies initiated to drive a certain objective might actually go counter to that objective if left too long.
So if the Governor said that premature withdrawal will hurt recovery, perhaps he said that very advisably in consideration of the macroeconomic situation in India and around the world today. As I said before, I am sure that the RBI is very conscious of timing and sequencing the withdrawal and will do it. Now going back to the 2008 crisis, I certainly have concerns about withdrawing timing. We talked about it in our policy statements, in our media interviews because withdrawal from easing has to be very deliberative, very thought through, very well planned and a lot of forward guidance has to be given.
In the event we were wrong footed in 2008 because of a number of circumstances. This is not the time or occasion to go into all that but I do want to say that the real time data is telling us something different from what actually was happening underneath. In 2008, some errors of judgement were made and I am sure that the Reserve Bank is informed by the lessons of that crisis.
RBI Governor Shaktikanta Das has given a forward guidance of accommodative monetary policy this fiscal, continuing in the next fiscal. At a time when there is so much uncertainty, is it really a good idea to commit to such long-term guidance when inflation is well above the upper end of the mandated band of 4% to 6%?
There is a conundrum there because financial and economic conditions are uncertain and the market wants forward guidance from the central bank. It is when financial and economic conditions are uncertain that the central bank is least able to give forward guidance. So how much forward guidance to give and how definitive it should be, is a concern not just for the Reserve Bank but it is an issue that is discussed in central banking policies circles continuously. If you give too definitive guidance, then the central bank will be locking itself into a definitive action. On the other hand, if the forward guidance is not definitive, it is too vague and it is of no help.
The policy challenge for the central bank is to give guidance that is appropriate, reveal as much as is possible and is necessary but not spook the market. The most famous example of forward guidance that has gone wrong is the taper tantrum announcement by the Federal Reserve back in 2013 when they said that they were going to taper the quantitative easing. It was very clear that at some point of time it will be eased. But how the communication should be given and when that should be given went wrong.
So giving appropriate forward guidance definitive enough to be of some value to market participants in such a way that it does not spook the markets is very important. In this particular case, the forward guidance given by the Reserve Bank is very important in an uncertain situation like this. I believe that the Reserve Bank has done quite well to give forward guidance but they should also be thinking about when to exit, how to exit and what forward guidance to give in order to prepare the market for the exit.
Most economists believe that fiscal policy should lead with monetary policy and best lending support. Instead, in India, most of the heavy lifting has been done by the RBI with a relatively feeble response from the government. What do you think is holding the government back?
When there is a downturn, an economic crisis not just in India but around the world, both fiscal policy by the government and monetary policy easing by the central bank are needed. Ideally the coordination should be shared. In India, the burden has fallen disproportionately on the Reserve Bank and the government has not done its share. Yes the fiscal deficit which is budgeted at 3.5% is going to be probably double to 7% or perhaps even higher. But much of that has gone to make up for the revenue lost and very little by way of fiscal spending — maybe 2%. This has been because the government has not spent enough on supporting lives and livelihoods. And why has the government not done this? I can only speculate that it was perhaps out of concerns about fiscal sustainability.
The FRBM committee said the debt to GDP ratio should be at 60%. It is going to be 80% this year and perhaps go much higher and so the government is concerned about fiscal sustainability and you spoke about inter-country comparisons. Yes rich countries have been able to throw the kitchen sink at the problem and they have had capacity for massive fiscal easing which we do not have. We must remember that India entered the crisis in a weak fiscal state and so the ability for fiscal easing was quite limited.
The government’s caution or reticence was perhaps informed by the concerns about fiscal sustainability. But whatever the government has spent, it has spent wisely on supporting MGNREGA the employment guaranteed scheme and on supporting medium and small industries which have been worst hit by this crisis and to some extent in supporting health infrastructure.
I believe going forward, in the next Budget, the government should be spending more on livelihood support by way of MGNREGA. They should be spending more on supporting medium and small industries and they should be spending more on supporting infrastructure because that will lay the foundation for medium term growth. In the next budget, the government should loosen the fiscal strings more than they have done this time around in this year.
I know that the Finance Minister listens very carefully to your advice. Your core central banking inflation targeting idea of monetary policy committee was really to put monetary policy formulation in the hands of the committee rather than the RBI Governor alone. But has its very purpose been defeated with the RBI bypassing the MPC by tinkering with liquidity and lowering interest rates? What purpose has the inflation targeting regime served?
So please allow me to give a little bit of context to this. We introduced inflation targeting in India in 2015. In the first three to four years, after the introduction of inflation targeting, up to 2019, inflation was very much within the band and close to the centre of the band of 4%. So every consensus was forming around the view that the inflation targeting framework has served India very well.
I believe that endorsement was premature because in the first four years after the inflation targeting framework was introduced, the framework was not tested. Domestic demand conditions were very benign and there were more external situations to pressure inflation in India but over the last one year, after Covid hit us, the inflation targeting framework has a counter test because 4% is low, indeed negative but inflation is firming up above the inflation target. So, how does RBI react, how does the MPC react to a situation like this when recovery has to be supported with inflation in sight?
MPC has interpreted its mandate flexibly to support growth and recovery even as inflation is above target in the so called expectation that in the weeks and months ahead, inflation will ease because supply chains will normalise as bumper food crops come into the market.
If you talked about the RBI as an institution, MPC is probably working at cross purposes because you it is important to get some context. Central banks have two instruments, an interest rate instrument and the balance sheet instrument. In the inflation targeting framework in India, MPC has been given only the interest rate framework, that is control over the repo rate. The entire balance sheet instrument has been left with the RBI executive and indeed even the repo rate has been left with the RBI executive. I am not saying it has happened, but it is quite possible. It is quite imaginable that there will be a situation where the MPC and the RBI executive will work at cross purposes. So when the inflation targeting framework comes up for review in March next year, it is very important to fix some of these things based on the experience over the last four years. I do not know if we have the time to go into this but this is one area that needs to be fixed when the inflation targeting framework comes up for review in March.
Yes, certainly is much fine tuning as far as the inflation policy framework is concerned but in hindsight, we also paid a very high price in terms of the growth foregone by interpreting the inflation target very rigidly at 4%?
It depends on the regime at that time and on the appreciation of the macroeconomic situation by RBI. Perhaps in order to make up for the high inflation up until 2013, some compensation was done. Today central banks around the world are talking about inflation over a period of time and not at a point of time. The Federal Reserve in its inflation targeting review said that they are going to be using that phrase for longer which is that they are going to target average inflation and not point by point inflation.
From that perspective, what RBI has done has been quite appropriate to compensate for high inflation in an earlier period of time and perhaps they have kept inflation low.
