Most economists expressed surprise when the RBI's Monetary Policy Committee (MPC) announced a radical change in its policy stance from ‘accommodative ‘to ‘neutral’ in its 8 February monetary policy. Questions were raised (including by this writer) whether the panel acted in a hurry by changing its policy stance even when there are uncertainties on growth disruptions due to cash-crunch impact.
There is still an element of uncertainty on how the growth situation will finally evolve. But, purely going by the third quarter GDP numbers (which showed a 7 percent growth in October-December) and a sharp pick up in retail inflation in recent months, the MPC may have got the trends correct and its early decision to move to a neutral stance wasn’t a mistake. In its February policy, both the MPC and the central bank didn’t seem to know how exactly the demonetisation impact will play out thereafter. The MPC itself acknowledged this lack of certainty when it said, “ the committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the transitory effects of demonetisation on inflation and the output gap play out.”
But in the hindsight, the panel’s assumptions on growth-inflation dynamics seem to be correct. If the 7 percent Q3 GDP number is true, the demonetisation never played havoc in the economy except creating short-term pain in November and December. This, coupled with, a visible jump in the retail inflation to 3.65 percent in the month of February from 3.17 percent in January, and a similar increase (from 5.25 percent to 6.55 percent) in wholesale prices indicate that monetary policy would have had little scope to go for rate cuts in the approaching reviews.
Typically, a central bank considers the situation conducive to remain in an accommodative stance when the inflation is benign and economic growth appears to be weak. As per the numbers (especially Q3 GDP), economy is doing alright and inflation is picking up. With summer approaching, vegetable prices will be even more under pressure. Along with this, hardening of commodity, crude prices and inflationary impact of GST would mean inflation worries would remain high in the remaining part of the year, narrowing any gap for rate cuts.
As for the growth is concerned, Q3 was the quarter when the impact of note ban was supposed to be more visible. This never happened going by the CSO numbers. If the Q4 numbers too come good and the economy grows by 7.1 percent for the full year, demonetisation will be a ‘no problem’ for the economy. Thus, in the hindsight, MPC appears to have got the early trends right. The only risk to this assumption is that if growth numbers are revised downwards sharply sometime later this year when the final numbers come and inflation surprises on its course.
This is also possible. The Q3 initial GDP estimates have come in favour of its policy stance, but when the final figures come later and the widely expected impact on the informal sector, which constitutes 40-45 percent to GDP, gets reflected in the numbers, it is quite possible that we will see a drastically different growth picture. As such, there are sufficient examples of major revisions in the initial numbers if one looks at the past data releases. The guessing game on the actual impact of demonetisation on GDP is still on. But, if the CSO numbers so far offer any clue, the cash-crunch did nothing to harm the economy and, hence, MPC’s February stance was right.
(Data support from Kishor Kadam)
Updated Date: Mar 15, 2017 18:34 PM