The Monetary Policy Committee (good folks responsible for setting interest rates in the country) decided to leave them as-is yesterday (at 4%) after deliberating on the matter for three days. However, that doesn’t mean there isn’t a story here.  In fact, the Monetary Policy Report — published on the same day, had a lot of new insights on the current state of the economy. So in today’s Finshots, we will talk about all the interesting bits from the report and more.


The Story

For starters, RBI’s view on the current and future state of the economy mirrors what most experts have been contending so far. Growth is likely going to be more robust this year. Vaccination drives could aid recovery in consumer demand. And government initiatives to rope in new investments may provide significant upside to our economic prospects. However, rising oil prices, global risks and inflation could act as dampeners.

More importantly, we still don’t know how the second and third wave of Covid infections might affect our future. If the virus and its mutant variants start wreaking havoc once again, we might have to start dialling back those optimistic projections. In the meantime, however, the RBI has promised to ensure ample liquidity. That’s them saying — “Listen, we’ll make sure there’s enough money going around if you’re looking to borrow and invest. We have our ways and means. And you don’t have to worry.” In fact, they even went on to say that they’d be particularly happy accommodating some more if only inflation remained within expectations.

After all, that’s the central bank’s biggest concern. For a while now, prices of food, telecom services, and other household goods have been on a rise. Why, you ask?

Well, for all sorts of reasons. Primarily because oil prices have been on the rise. And since a rise in fuel prices often translates to an increase in transportation costs, you can see how prices of most commodities would start appreciating in tandem. But thankfully, they’re not completely out of whack. They are still within reasonable boundaries. But it’s on the RBI to ensure price stability persists and that is definitely not an easy task. For starters, you have to constantly guess which way the prices are likely to swing. In effect, you have to forecast inflation and then figure out ways to counter its effect.

And an oft-cited criticism of the Reserve Bank of India is that it consistently fails to forecast inflation and growth rates accurately. According to the critics, this is a rather serious transgression on the part of the bank, mainly due to the fact that these numbers are then used to justify the monetary policy calibrations [changing interest rates etc]. How could the collective wisdom of the Monetary Policy Committee, the governor, the deputy governors, the modelling experts and other technical advisors all be so woefully inadequate to deal with what seems like a rather straightforward problem?

To answer that question we must first look at the data that’s used to predict these future outcomes. As Duvvuri Subbarao, the former Governor of the RBI points out — “The Reserve Bank operates within the universe of knowledge available in real-time, and that universe is largely shaped by data. If the data are reliable and available in good time, policy response can be accurate and confident. But the Reserve Bank is oftentimes wrong-footed because of the questionable quality of data.”

However, critics were unrelenting in their pursuit and they kept picking flaws in RBI’s inflation forecasting model — often contending that it had a proclivity to overestimate inflation. And the RBI finally seems to have amended its model slightly in a bid to better its prediction.

There was also this interesting bit about Climate Change.

See, data can be skewed by all sorts of things and it’s incumbent on the central bank to capture these variables. However it's quite possible that you might miss a few variables because you didn't think they were important enough. Variables like climate change for instance. And while this was once an afterthought, it's no longer the case today. Droughts and flash floods, precipitated by climate change can affect the prices of food and other commodities. And it's time we began accounting for them. So the RBI finally seems to have acknowledged this much and maybe they'll soon start incorporating some of these variables in their projections.

So yeah, there were a bunch of new insights in the report and hopefully, this story did a good job of capturing some of the most salient ones.

Until next time…

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