Why in the news?
- Countries across the world have been affected by the Covid pandemic which has affected their economy adversely. Central banks of different countries, including RBI, have adopted expansionary recovery policies with steps like slashing of market rates, flooding the market with an unprecedented amount of liquidity and instituting a slew of measures for targeted assistance to especially distressed sectors.
- However, there is always the challenge of an economic crisis while managing an economy as there are inherent challenges associated with recovery plans.
Challenges before the RBI
- First challenge before the RBI is non-disruptive exit out of the easy money regime. Reversing a crisis-driven expansionary policy has a deliberative process, with the timing and sequencing carefully planned. Any missteps on the exit path by way of commission, omission, or importantly communication can be costly in macroeconomic terms.
- Biggest challenge before the RBI will be to manage the tension between restraining inflation and supporting the recovery. Monetary Policy Committee have been unable to decide against any rate action out of consideration for growth and financial stability and this challenge is bound to be there in future also. As inflation can be caused by many factors, it will be really difficult for RBI to control inflation while focusing on growth.
- Another challenge apart from upside risk to inflation and downside risk to growth, is plight of savers who are being shortchange by low interest rates at a time of high inflation
- Another challenge will be to withdraw the ‘excess’ liquidity in good time. All the money that the central bank unleashed into the system is not doing much good. As we are out of that abyss now and it is time to think of an exit from “excess liquidity” concept in a good time.
- Excess liquidity will drive investors into dodgy ventures and threaten financial stability. As the RBI seeks to guard financial stability by normalizing liquidity, there can be chances of possible market tantrums.
- Another big challenge for the RBI going forward will be to restrain the rupee from appreciating out of line with fundamentals. There is the classic case of ‘the impossible trinity’ — of keeping doors open for capital flows while simultaneously maintaining a stable exchange rate and restraining inflation.
- During this fiscal year, RBI has absorbed nearly $90 billion to prevent exchange rate appreciation and to maintain the competitiveness of the rupee but it will be difficult to absorb more liquidity as rupee deteriorates further.
Way Forward It is better to be rough right, as Economist John Maynard Keynes said, than be precisely wrong. That should be the guiding principle for RBI as it navigates its way out of the crisis driven easy money policy. The RBI should refrain from doing adventurism and should have evolving dynamic policy to deal with changing economic conditions during the recovery plan.