Concerns of slipping into a deeper economic crisis emerge as the RBI continues with its accommodative monetary policies
The Reserve Bank of India-led Monetary Policy Committee (MPC) brewed a storm in a teacup by continuing its accommodative monetary policy stance—retaining the Repo rate (the cost of borrowing from the RBI) at 4 percent and the Reverse Repo (the cost of depositing funds with the RBI) at 3.35 percent.
The MPC is a device, initiated in 2016, to broaden and professionalise decision-making, beyond the prodigious talent available within the RBI which, incidentally, is the first statutory, autonomous, regulatory institution in India, in existence since 1935. The MPC meets at least quarterly to review the functioning of monetary policy and determine changes. The RBI members are evenly balanced by three outside experts—government nominees. In the event of a tie, the Chair (Governor of the RBI) has the casting vote. More importantly, an institutional mechanism has developed which transparently shares the thinking behind decisions and records dissenting views—a robust and useful gold standard for good governance.
An institutional mechanism has developed which transparently shares the thinking behind decisions and records dissenting views—a robust and useful gold standard for good governance.
Broken global supply chains, higher commodity prices, and the eye-watering cost of international transportation, can only come to heel as the world heals.
The dissenting view of the lone MPC member, against continuing accommodative monetary policy, is based on the downsides from excess liquidity sloshing about for an extended period, escalating asset prices, and adding to fiscal complacency.Our record in rolling back liquidity post a fiscal crisis is not perfect. The fiscal deficit, post the 2009 Global Financial Crisis (6.6 percent of GDP in FY 2010) never did come down below 3.5 percent (FY 2017) to the elusive 2 percent, despite supportive low oil prices. The marginally lower deficit of 3.4 percent of GDP in FY 2018 lacks credibility being massaged data, pushing expenditure on food subsidy off-balance sheet as incremental Food Corporation of India debt to be repaid in subsequent years. The logic is sound that it is not the extent of liquidity infusion but the risk of not being able to reign in deficits over an extended period, that risks the loss of fiscal discipline becoming an embedded, toxic habit. The fear of high inflation because of an extended, uncertain period of high fiscal deficits cannot be ignored. But the interplay between monetary policy and supporting fiscal policy should not be overlooked either. The RBI is sanguine that inflation will trend downwards from 5.6 percent in December 2021 to an average of 5.3 percent by end FY 2022 on the back of good harvests and 4.5 percent in the next fiscal FY 2023. The dissenting member is right that at 4.5 percent inflation would still be 0.5 percent above the target of 4 percent. In addition, unknown shocks could disrupt this assessment, pushing it to above the prescribed outer bound of 6 percent with negative consequences.
As a percentage of GDP, excise duty, and cess collected by the Union and state governments on the sale of petroleum products remained within a range of INR 2.5 to 2.1 percent of GDP, barring FY 2016 and 2017 when 3 and 3.4 percent of GDP was collected. During the pandemic years (FY 2021 and 2022), tax flows from petroleum products became a mainstay of cash-strapped governments, which resorted to “tax gouging” a source of indirect tax, relatively “invisible” to all, but the more affluent end-consumers who own motorised transport.
The graph below illustrates how tax on the sale of petroleum products levied by the Union government moved in a countercyclical pattern to the price of imported crude (which accounts for more than 80 percent of domestic consumption) till 2019.
The newly-elected BJP government in 2014 got a reprieve from FY 2016 to FY 2018, when crude prices moderated from the highs of the earlier years. This opportunity was used to increase taxes on the sale of petroleum products. The tax collected over the four years FY 2015 to 2018 was equal to 1.7 percent of the aggregate GDP. This was partly used to reduce the fiscal deficit by 1 percent of GDP from 4.5 percent in FY 2015 to 3.5 percent by FY 2018— a virtuous allocation.
During the pandemic years (FY 2021 and 2022), tax flows from petroleum products became a mainstay of cash-strapped governments, which resorted to “tax gouging” a source of indirect tax, relatively “invisible” to all, but the more affluent end-consumers who own motorised transport.But the trend for high receipts from this tax on petroleum products continued, including during the pandemic years, increasing from INR2.39 trillion in FY 2018 to INR3.71 trillion in FY 2022(RE)—an increase of 55 percent versus nominal GDP growth between these two years of 35 percent. An opportunistic increase in tax to keep consumer prices stable, in an era of falling oil prices, is savvy fiscal management. But if continued when the price of imported fuel is also increasing (FY 2022, 2023) it risks inflation.
A downward reduction in tax amounting to INR 10 per litre of petrol could reduce inflation by 0.6 percent if the direct prices of other inputs remain stable.The FY 2023 Budget seems aligned with this proposition. Union tax revenues on petroleum products are estimated at INR 3.11 trillion—16 percent lower than the current year. A matching sacrifice by state governments could provide a second cushion against inflation. Such co-ordination between the fiscal and monetary authorities is not explicit but can be read between the lines of possible strategies, should the need arise. The Governor of RBI, possibly, sleeps well at night because of this fiscal cushion. There are downsides to the RBI being cozy with the government—especially when the sector it regulates, is dominated by publicly-owned behemoths. But the upside of an inside track in government is also an asset.
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Sanjeev S. Ahluwalia has core skills in institutional analysis, energy and economic regulation and public financial management backed by eight years of project management experience ...
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