Even as it advanced its projections for an economy recovery, the RBI warned that keeping the system flush with funds, to keep long-term rates low, is “taking a step into the unknown and could kindle inflation without reviving growth”.
“If the current upturn is sustained in the ensuing two months, there is a strong likelihood that the economy will break out of contraction of the six months gone by and return to positive growth in Q3FY21,” RBI said. However, the central bank warned that inflation could corrode nascent growth impulses that are making their appearance.
The RBI on Wednesday made public its concerns over inflation in a report on the state of the economy and an article on long-term interest rates both published in its monthly bulletin. According to the RBI, the economic momentum of September has been maintained and the contraction appears to be short-lived. However, it has raised serious concerns over inflation.
“The foremost downside risk is the unrelenting pressure of inflation, with no signs of waning in spite of supply management measures,” the RBI said. It added that there was a ‘grave risk’ of generalisation of price pressure, unanchoring of inflation expectations feeding into a loss of credibility in policy interventions and the ‘eventual corrosion of nascent growth impulses’ that are seen.
Explaining why it sees inflation as unrelenting, the RBI said that measures such as the imposition of stock limits on onion traders, imports of potatoes and onions (without fumigation) and a temporary reduction in import duties on pulses have not managed to keep prices under check. “There is a grave risk of generalisation of price pressures, unanchoring of inflation expectations feeding into a loss of credibility in policy interventions,” the RBI said.
According to the RBI, two major risks are collapse of external demand due to a second Covid wave globally. Finally, there was a risk of stress in the household and corporate sector passing on to the financial sector. “If the green shoots manage to survive these risks and take root, the key question is what will be the drivers of the recovery?” the RBI said.
The RBI’s comments come a day after its monetary policy committee’s external member Ashima Goyal said in an interview to news agency Cogencis that there was no need to worry about the medium-term inflation target until the output gap is closed. The central bank paused its rate cuts after the first quarter over fears of inflation.
Besides inflation, the RBI also faces the challenge of managing the government’s borrowing programme. To keep rates low, the RBI has infused significant amount of liquidity into the money markets. The surplus liquidity in the market is reflected in the money that banks park with the central bank under its liquidity adjustment facility which stood at Rs 4,46,802 crore in October 2020.
(This story originally appeared TOI in on Nov 12, 2020)