[Editorial Analysis] Growth Pangs

Mains Paper 3: Economy
Prelims level: RBI Monetary Policy 2020
Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment

Context:

• In its December meeting, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) voted unanimously to maintain the status quo on interest rates.

• The decision, in line with expectations, was driven by retail inflation continuing to remain well above the MPC’s upper tolerance level.

• While space for further easing in the near-term is likely to be restricted given the likely trajectory of inflation, an extended pause implies that interest rates will remain low for a long period of time.

• Further, by continuing to maintain its accommodative stance and providing firm forward guidance- the MPC expects to maintain its current stance at least during the current financial year and into the next financial year.

• The committee has sent a clear signal of its intent to continue to attach primacy to growth considerations, serving well to boost sentiment.

Few concepts:

1. Monetary Policy-
a. Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act. The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
b. The Monetary Policy Committee is responsible for fixing the benchmark interest rate in India. The meetings of the Monetary Policy Committee are held at least 4 times a year (specifically, at least once every quarter) and it publishes its decisions after each such meeting.
c. The current mandate of the committee is to maintain 4% annual inflation until 31 March 2021 with an upper tolerance of 6% and a lower tolerance of 2%.

2. What Is an Interest Rate?
• The interest rate is the amount a lender charges for the use of assets expressed as a percentage of the principal.
• The interest rate is typically noted on an annual basis known as the annual percentage rate (APR).
• The assets borrowed could include cash, consumer goods, or large assets such as a vehicle or building.

3. What Is a Bank Rate?
a. A bank rate is the interest rate at which a nation’s central bank lends money to domestic banks, often in the form of very short-term loans. Managing the bank rate is a method by which central banks affect economic activity. Lower bank rates can help to expand the economy by lowering the cost of funds for borrowers, and higher bank rates help to reign in the economy when inflation is higher than desired.
b. The RBI regularly controls the level of credit supplied by the commercial banks by changing the bank rate. When Bank rates changes it suddenly impacts on Economy. When RBI decrease bank rate it is called ‘cheap money policy’. Money supply in the economy is increased.
c. When RBI increases bank rate, it is called ‘dear money policy’. Money supply in the economy is decreased. RBI uses bank rate to balance economic growth and inflation.

4. Accomodative Stance-
An accommodative stance means a central bank will cut rates to inject money into the financial system whenever needed. A change in this stance to ‘neutral’ means RBI will alter rates in any direction to control the money supply in the system. This was the surprise that led to the fall in bond and stock prices.

5. Retail Inflation-
a. When we talk about the rate of inflation, it often refers to the rate of inflation based on the consumer price index (CPI). The CPI tracks the change in retail prices of goods and services which households purchase for their daily consumption.
b. To measure inflation, we estimate how much CPI has increased in terms of percentage change over the same period the previous year. If prices have fallen, it is known as deflation (negative inflation). The Central Bank (RBI) pays very close attention to this figure in its role of maintaining price stability in the economy.
c. The CPI monitors retail prices at a certain level for a particular commodity; price movement of goods and services at rural, urban and all-India levels. The change in the price index over a period of time is referred to as CPI-based inflation, or retail inflation.
d. Generally, CPI is used as a macroeconomic indicator of inflation, as a tool by the central bank and government for inflation targeting and for inspecting price stability, and as deflator in the national accounts.

Current situation:

• The outlook on inflation continues to remain a matter of concern. The RBI now expects retail inflation to remain elevated at 6.8 per cent in the third quarter, trending down to 5.8 per cent in the fourth quarter.
• While this build-up in inflation is due to supply side disruptions, excessive margins and indirect taxes, core inflation has also edged upwards, providing evidence of spreading price pressures.
• The RBI now expects inflation to range from 4.6-5.2 per cent in the first half of next year. However, inflation may well firm up as demand picks up. This would lower any changes of further easing of policy rates.
• There is excess liquidity in the system and as a consequence we experience collapse in the short-term interest rates. There were expectations that the central bank would announce measures or provide some guidance on how it plans to suck out the excess liquidity from the system.
• However, the governor’s commentary seems to indicate that the excess liquidity will not be withdrawn hurriedly, as growth concern remains. This will have a calming effect on bond yields.
• Further, the decision to expand the on-tap targeted long-term repo operations to stressed sectors, in line with the government’s Emergency Credit Line Guarantee Scheme, signals intent to continue providing liquidity support to the economy.
• On the growth front, with economic activities bouncing back stronger than expected, the RBI has revised its growth forecasts, pegging the contraction in GDP for the full year at 7.5 per cent, up from its October policy forecast of 9.5 per cent. Growth is now expected to turn mildly positive in the second half of the year.

Steps to recover economy:

1. Invest in sustainable infrastructure-
a. Infrastructure investments are an effective way to boost economic activity and create jobs.
b. India too should take this opportunity to increase support for renewable energy, particularly rooftop solar, through appropriate policies and business models. Decentralized solar power can help spread critical services in remote regions if the upfront capital constraints can be addressed. It should revisit the potential import duties on solar panels, since this may not increase domestic production, but may raise the cost of solar power.
c. Similarly, scaling up the electrification and adoption of public transport will be critically important to reduce traffic congestion and air pollution. This should involve closer coordination with the electricity sector and a greater focus on vehicle charging infrastructure.
d. Continued investment in cold storage facilities and supply chains will ensure the preservation and timely delivery of agricultural produce and reduce losses to farmers.

2. Build the resilience for the most vulnerable-
a. About 90% of India’s workforce is informally employed, which includes gig economy workers. This population is extremely vulnerable to economic shocks and needs greater access to formal credit and social safety nets such as insurance and pension schemes.
b. Beyond employment guarantees, a universal basic income – broader than current schemes that are conditional upon occupation and land ownership – can help provide vital resources for subsistence, or for investing in education and health.
c. Greater access to bank accounts for the 20% of adults without one, per 2017 data, would help efficiently deliver this income to households.
d. Lastly, it is critically important to expand access to clean water, clean air and primary health care. These will improve life expectancy and increase economic and physical resilience.

3. Use fiscal mechanisms for recovery and resilience-
a. Fiscal mechanisms can help support recovery and resilience efforts, while promoting low-carbon development. The Indian government has announced an economic stimulus of INR 1.7 trillion ($24 billion), and is exploring another bailout of INR 750 billion for Micro, Small and Medium Enterprises (MSME), among other steps.
b. Though MSMEs need immediate financing to deal with their wage bills, the government can also infuse capital for them to undertake needed industrial energy efficiency upgrades.
c. Several sectors, like the aviation and auto industries, will need support in order to recover. This will require consideration of the fiscal situation, and it presents an opportunity to encourage greater sustainability by making this support conditional on cleaner technologies and fuel efficiency.
d. Meanwhile, the government can increase taxes on luxury sectors with high environmental impacts. It can also use this opportunity to rationalize fertilizer subsidy and increase taxes on fossil fuels, with the savings and proceeds returning to target populations through cash transfers or social safety nets.

4. Encourage long-term change in behavior-
a. The current crisis has changed patterns of consumption. Electricity usage patterns have shifted as people are working from home on more flexible schedules. Non-essential purchases have temporarily ceased.
b. All these offer an opportunity for implementing demand-side solutions to drive long-term behavior changes for more sustainable development.
c. For instance, encouraging conservation in energy – through nudges and tariff reforms – can drive down consumption. Promoting reuse, recycling and repair models for consumption can contribute to a circular economy and reduce the waste generated by current business models.
d. Supporting the continuation of work-from-home policies can drive down road traffic congestion and air pollution.
e. While encouraging the continuation of these new trends, the government should also foster new behaviors. For example, with nearly 80% of the population expected to be in the middle-income bracket by 2030, it is extremely important to attract them to public transport options.
f. The government could achieve this through expanding connectivity to business districts, improving and streamlining the network and discouraging the use of cars through measures such as road congestion pricing, paid street parking and higher taxes on luxury vehicles.

5. Regulate enabling technologies-
a. Finally, it is useful to consider that the future may see greater employment in the gig economy and e-commerce sectors, as well as in new technologies that can help support future response and resilience mechanisms.
b. While supporting the development of such sectors, it is important to put the right regulations in place to ensure data privacy and consumer protection.
c. The decisions taken today can provide immediate relief, but also secure a lasting economic recovery, increase community resilience and ensure a long-term pathway to sustainable development. We shouldn’t let this chance slip.

Conclusion:

• However, a sustained pick-up in economic activities will depend on continued policy support, especially higher government spending, which until now, despite the announcement of various relief packages, has not met expectations.

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Prelims Questions:

Q.1) Consider the following statements:

1. Lachit Borphukan was a commander and Borphukan (Phu-Kon-Lung) in the Ahom kingdom, located in present-day Assam.

2. The best passing out cadet of National Defence Academy is conferred the Lachit Borphukan gold medal every year from 1999.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer: C

Mains Questions:

Q.1) What are the steps need to be taken by the RBI to recover economy during post-pandemic?

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