Mumbai, April 29 (FN Agency) With a view to recreate a policy environment conducive for private sector-led growth in the post-Covid period, timely rebalancing of monetary and fiscal policies may be necessary, a report by the Reserve Bank of India has said. According to the Report on Currency and Finance 2021-22 of the RBI, the recovery in economic activity remains stimulus dependent even as new risks to growth and inflation have emerged from the war in Ukraine and normalisation of monetary policy in the US. “For restoring and recreating a policy environment conducive for private sector-led growth post-Covid, timely rebalancing of monetary and fiscal policies may become necessary given the current configurations of debt and liquidity,” the report said. It noted that large surplus liquidity that helped financial conditions to ease significantly during Covid needs to be withdrawn in a calibrated manner.
“This is because when surplus liquidity persists at above 1.5 per cent of NDTL, for every percentage point increase in surplus liquidity, the average inflation could rise by about 60 basis points in a year. Surplus liquidity within the threshold of 1.5 per cent of NDTL, however, is found to pose no significant risks to inflation.” Since inflation exceeding a threshold of 4-6 per cent is inimical to growth, adequate supply-side measures to contain inflation should be the priority rather than passive monetary accommodation through ample surplus liquidity, the report said. It further said that empirical estimates suggest term premium coming under pressure once the Central government debt exceeds a threshold level of about 55 per cent of GDP. “While surplus liquidity is found to have a significant sobering effect on term premium, easy liquidity should not be a policy instrument to raise the tolerable level of debt in the economy.
Moreover, when general government debt exceeds another critical threshold level of about 66 per cent, it is found to dampen growth.” Further, the scenario analysis suggests that even under best possible macroeconomic outcomes, general government debt may not decline to below 75 per cent of GDP over the next five years. “If adverse scenarios materialise, in fact, debt may increase. A medium-term transparent strategy of debt consolidation aimed at reducing general government debt to below 66 per cent of GDP at the earliest would be important to secure the medium-term growth prospects of India,” the report highlighted. The report further suggested that fiscal consolidation is unlikely to be growth retarding, as the time varying fiscal multipliers for India suggest.
It noted that once the economy returns to steady state, fiscal multipliers can change from greater than one during a crisis to less than one or even negative. The report suggested that the debt path over the next five years, even under the best-case scenario, will further squeeze fiscal space unless strategic policy efforts covering both taxes and expenditure aim at targeted consolidation, without relying perpetually on the wobbly comfort from a favourable interest rate minus growth condition of debt sustainability. “With monetary policy prioritising price stability and pursuing output stabilisation in an environment in which debt sustainability is sought to be achieved by fiscal prudence, the assignment rule is satisfied bringing in its train macroeconomic stability to support sustainable growth,” the report added.