Michael Debabrata Patra: Future readying India's monetary policy
Address by Dr Michael Debabrata Patra, Deputy Governor of the Reserve Bank of
India, at the Mid-Career Training Programme for officials of the Indian Administrative
Service at the Lal Bahadur Shastri National Academy of Administration, Mussoorie, 9
July 2024.
* * *
Namaskar! Good afternoon
I am honoured to be invited to the Lal Bahadur Shastri National Academy of
Administration (LBSNAA), a temple of independent India with a rich and hallowed
history that predates independence. I thank Madam Sowjanya for her gentle
perseverance and deft management of logistics that made it possible for me to be here.
I understand that this is the 18th round of phase IV of the Academy's mid-career
training programme. Participants here have already put in 15 to 18 years in the service
of the nation and are, therefore, primed to lead our country over the next 40-50 years in
the quest of our national vision of becoming a developed country. The nation looks up
to you to fulfil that vision, as you will wield public policy and confront the challenges of
governance as you steer the nation towards its aspirational goal. While doing so, you
will have to manage tectonic vicissitudes in the form of organisational and technological
changes as well as structural transformations in various sectors of the economy. I do
hope my talk will be able to shine a little light on the journey before you.
It is in this context that I will speak to you about monetary policy but I will situate it in the
milieu of the next forty to fifty years so as to bring out some perspectives on the
opportunities and challenges that will rise up to meet you as you take India towards its
future.
First Principles
It is important to appreciate the guiding tenets that shape the design and conduct of
monetary policy.
First, within the arsenal of public policy instruments, monetary policy is distinguished by
its rapid deployability because the situations it has to encounter warrant immediate
action. Hence it is typically assigned the task of stabilisation of the economy around its
productive capacity. Illustratively, when aggregate demand or total spending exceeds
the country's productive potential, imbalances develop that can easily throw the
economy off course. The first signs of these imbalances are usually price pressures or
inflation. Accordingly, monetary policy acts to dampen aggregate demand and bring it in
alignment with productive capacity. Analogously, when demand falls below productive
capacity, deflationary conditions can develop and hence monetary policy has to boost
the economy to restore balance between demand and supply.
Second, monetary policy has to be forward looking. At any point in time, the information
available to monetary policy authorities on the goal variables is lagged - on a measure
of economic activity such as gross domestic product (GDP) for instance, information
available at any point of time is typically three months old, i.e., relating to
JanuaryMarch in India; information on consumer prices in India is available only for May.
Furthermore, policy impulses travel through the structure of the interest rates with
variable and uncertain lags - changes in the policy interest rate take time to be fully
reflected in lending rates charged by banks and other financial institutions. So, more
often than not, monetary policy has to shoot blind. Besides, the goal variables are in
motion and hence, monetary policy has to shoot forward. For this purpose, it uses all
available information like a radar screen to track the formations of moving goal
variables, and target them accurately. This task becomes even more complicated when
dealing with their likely course into the unforeseen future such as over the next forty to
fifty years. We shall get there presently.
Third, as Jan Tinbergen, the 1969 Nobel Prize winner for economics showed, any
policy is most efficient in achieving its goals when it follows an assignment rule - if there
is one instrument such as the policy interest rate, there should be one goal. If instead,
monetary policy is overburdened with too many goals but is hamstrung with too few
instruments, there is every likelihood that the instrument will end up hitting none of the
goals.
Fourth, monetary policy should be conducted in terms of some rule like behaviour that
binds it to pursue its goals across time. Instead, if it falls prey to the temptation of
exploiting short-run trade-offs - like abandoning inflation control in the short run and
boosting growth or what economists call time inconsistency - it will ultimately lose sight
of its objective because in the short-run pursuit of growth, inflation may be allowed to
rise to levels that can be inimically harmful to growth.
Fifth, modern monetary policy authorities have found that the efficacy of monetary
policy is enhanced when it is supported by clear and transparent communication about
the intent of policy actions and stance in the context of its goals and the manner and
time frame in which they are to be achieved. Communication makes monetary policy
accountable as the public is able to measure its impact. This, in turn, makes it credible
by binding the policy authority to its stated intent and constraining unbound discretion in
seeking short-term gains at the cost of medium-term goals. In fact, high credibility
obviates the need for large policy changes or even of any changes at all if the public
believes in the welfare orientation of policy. As a result, communication helps to anchor
the expectations of the public to the goals of monetary policy so that policy makers and
all stakeholders work with a common set of expectations. Stability in the expectations
around policy, its conduct and its goals engenders macroeconomic stability which
provides solid foundations for medium-term growth prospects.
Reading the Pitch
Monetary policy has an intrinsic domestic orientation. Hence, a good understanding of
the characteristics of the economy it serves and the path along which economic activity
is most likely to evolve is key to fashioning and implementing good monetary policy. In
the context of the time horizon that I chose at the outset, the question to ask is: where
are we today, and where do we go from here?
By 2023-24, i.e., the year just gone by, India had become a 295.4 lakh crore or US$ 3.6
trillion dollars economy at current exchange rates. At a per capita income of 2,07,030 or
US$ 2,500, India belongs in the lower middle income group of countries. Reaching here
has been an eventful and arduous journey, marked by what statisticians call 'structural
breaks'. The first one occurred in 1980, marking the end of a period since
independence when GDP growth averaged 3.6 per cent or the so-called Hindu rate of
growth. It was the age of inwardness. From 1980 up to the second break around 2002,
growth trended up to an average rate of 5.5 per cent as India opened up, dismantled
barriers to trade and capital flows, and peered outwards. The third break was caused by
the pandemic in 2020. Between 2002 and 2020, the gains of liberalisation and structural
transformation were consolidated and trend growth shifted up to close to 7 per cent,
only to be interrupted by the precipitous decline in GDP by 5.8 per cent in 2020-21.
Backed by nation-wide inoculations and the steadying hand of astute macroeconomic
policy support, however, there has been a robust rebound in the post-pandemic period.
Although too early to tell in view of lack of adequate data points, another structural shift
may be forming that is powering trend growth to above 8 per cent - the fastest growing
major economy in the world today. In 2024, the International Monetary Fund (IMF)
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projects that India is going to contribute about one-sixth of global growth .
It has been estimated that if India can grow at the rate of 9.6 per cent per annum over
the next ten years, it will break free of the shackles of the lower middle income trap and
become a developed economy. These gains need to be reflected in per capita income
with two milestones - a per capita income level of US$ 4516-14,005 to reach middle
income country status, and beyond that level to attain the position of a developed
country today. By 2047, however, the developed country threshold will have moved up
to US$ 34,000.
Current exchange rates determined in the market are subject to bouts of volatility and
idiosyncratic behaviour that makes them diverge from reality. Hence, their application
as denominators to GDP measured in national currencies may not be appropriate for
cross-country comparisons. An alternative measure is purchasing power parity (PPP). It
is the price of an average basket of goods and services in each country. With PPP, the
comparison changes dramatically. In terms of PPP, India is the third largest economy in
the world. The US$ 5 trillion milestone for 2027 translates to US$ 16 trillion in PPP
terms. The Organisation for Economic Cooperation and Development (OECD) projects
that in PPP terms, India will overtake the US by 2048 to become the second largest
economy of the world.
To paraphrase from Victor Hugo, there is nothing more powerful than a country whose
time has come. The age of Japan started in the 1960s and lasted up to the 1980s. The
age of China began in the early 1990s, taking it to the position of the second largest
economy of the world. It is from 2010 that India's time has come. Several forces are
coming together for India to surge ahead and assume its rightful place as a world leader
over the next two-three decades.
Tailwinds
In the formulation of monetary policy, it is considered good housekeeping to evaluate
the balance of risks. There are several positive energies that are helping to shape the
vision of India's future over the next few decades. The playout of these forces will
condition the setting of future monetary policy.
First, there is a traditional advantage that is likely to continue working in favour of
India's growth prospects. The development process has been predominantly driven by
capital accumulation, which makes investment the main lever of growth. The investment
rate peaked at close to 40 per cent of GDP in 2010-11 but moderated unevenly
thereafter until 2020-21. During 2021-23, however, it has stabilised around 31.2 per
cent and is showing signs of acceleration. Historically, India's investment has been
financed by domestic savings, with households being the prime provider of resources to
the rest of the economy. In the period 2021-23, the gross domestic saving rate has
averaged 30.7 per cent of gross national disposable income. Thus, unlike many
countries, India does not have to depend on foreign resources, which play a minor and
supplemental role in the growth process. In fact, the mirror image of this phenomenon -
the current account gap in the balance of payments - has remained modest at around 1
per cent of GDP in 2023-24. This provides insulation to the Indian economy from
external shocks and imparts viability and strength to the external sector. Illustratively,
India's gross external debt, which is the accumulation of current account deficits over
time, is less than 20 per cent of GDP and almost entirely covered by the level of foreign
exchange reserves. Debt service, i.e., interest and principal repayments are together
less than 7 per cent of current receipts. As regards the supersavers - households -
there is evidence of switching from financial saving to physical saving, with the latter
being financed by accretions to households' financial liabilities.
Second, the rising growth trajectory on which India is poised is entrenched by
macroeconomic and financial stability. After a long and arduous battle with the upside
pressures unleashed by the pandemic and geopolitical conflicts, and exacerbated by
sporadic onslaughts of food supply shocks, inflation has fallen back into the tolerance
band around the target of 4 per cent. This reflects the cumulative impact of steadfast
monetary policy actions and supply management. In fact, core inflation that excludes
food and fuel and is most amenable to monetary policy has fallen to its lowest level
ever. The RBI has anchored expectations by remaining committed to aligning inflation
with the target and regards the recent easing of price pressures as work in progress. It
projects inflation to average 4.5 per cent in 2024-25 and 4.1 per cent in 2025-26. The
taming of inflation lays the foundations of sustained high growth in the future by
improving consumption conditions, the investment outlook and external competitiveness.
Alongside macroeconomic stability, financial stability is getting reinforced by prudent
financial policies and active on-site supervision complemented with off-site surveillance,
which harnesses SupTech, big data analytics and cyber security drills. India's financial
sector is predominantly bank-based. Gross non-performing assets (GNPAs) in the
banking system have steadily fallen from their peak in March 2018 to 2.8 per cent of
total assets by March 2024. Adjusted for provisions, net NPAs are just 0.6 per cent.
Capital and liquidity buffers are well above the regulatory norms. Profitability is high and
this virtuous circle has supported a credit upswing. Stress tests for credit risk and
interest rate risk reveal that banks would remain above minimum capital requirements
even under severe stress scenarios. Similar improvements are evident among
nonbanking financial companies. The rising strength and resilience of the financial sector
augurs well for medium-term growth prospects as it is the financial sector which
intermediates the resource requirements of the growth process.
Another aspect of macroeconomic stability is the ongoing fiscal consolidation. As a
result, the general government debt which is estimated at 81.6 per cent of GDP at the
end of March 2024 is expected to decline to 78.2 per cent by end of this decade by the
IMF. Our projections show that if expenditures are increased on reskilling/upskilling the
labour force in the most productive sectors of manufacturing, investing in digitalisation
and promoting energy efficiency, the general government debt will fall even further to
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73.4 per cent of GDP by 2030-31 . This is significant in the context of the IMF's
projections that show the debt ratio as projected to rise to 116.3 per cent in 2028 for
advanced economies and to 78.1 per cent for emerging and middle-income countries.
A potent growth accelerator emerges from India's favourable demographic dynamics.
India's population, once regarded as a Malthusian curse, is now regarded as its
greatest asset in an inter-temporal perspective, especially when the rest of the world
ages rapidly and populations shrink. Today, every sixth working age person in the world
is an Indian. With a median age of 28 years, the share of the working age cohort in the
total population will keep rising upto the mid-2050s, with commensurate benefits in
terms of growth in income and savings. India's demographic dividend is expected to last
for more than three decades. Every effort must be made to reap this opportunity.
Another growth multiplier is India's digital revolution. India is emerging as a world leader
in leveraging digital technologies for transformative change. The trinity of JAM - Jan
Dhan (basic no-frills accounts); Aadhaar (universal unique identification); and mobile
phone connections - is expanding the ambit of formal finance, boosting tech start-ups
and enabling the targeting of direct benefit transfers. India's Unified Payment Interface
(UPI), an open-ended system that powers multiple bank accounts into a single mobile
application is propelling inter-bank peer-to-peer and person-to-merchant transactions
seamlessly. Payment systems in India operate on a 24 by 7 by 365 basis.
Functionalities like offline payments, payments through feature phones and
conversational payments have been incorporated. The internationalisation of the UPI is
progressing rapidly.
Headwinds
India's progress towards its developmental ambitions will encounter challenges or what
are termed in monetary policy analysis as downside risks. Successfully navigating them
will test the conduct of monetary policy as India forges ahead to seek its destiny.
The key to harnessing the demographic dividend is in raising the contribution of the
labour force to gross value added. In spite of recent improvements in job creation and
rewards to higher skills, the shares of both quantity and quality - which refers to returns
to skill formation - of India's labour is low by international standards. In terms of
appropriate skills for a specific job, only 51 per cent is employable, warranting
concerted efforts to re-skill and upskill the work force in tune with changing job
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requirements and technological change . More than 80 per cent of the workforce is
employed in the informal sector and this highlights the need for expanding the
formalisation of employment. Furthermore, India ranks low in women's participation in
the workforce. Increasing female labour participation is a key challenge, needing social
norms in favour of working women; incentivising diversity in educational institutions and
workplaces; flexible working hours and women friendly policies and facilities at work
places; and promoting work-life balance.
Another formidable challenge is the building of high quality infrastructure. India's per
capita investment in infrastructure at US $ 90 in constant 2015 dollars needs to be
scaled up by lifting infrastructure investment from around 4 per cent of GDP to at least 6
per cent of GDP. This will require enabling regulations, faster clearances, smooth land
acquisition and climate clearance policies, and adequate infrastructure finance. The
sustained infrastructure spending and logistics push across successive union budgets
is creating the environment for financing India's infrastructure goal.
The formalisation of jobs will be facilitated by developing a high class manufacturing
base to absorb low- and intermediate-skill labour migrating from primary occupation.
India largely bypassed manufacturing in its developmental journey - services account
for two-thirds of India's economy today while manufacturing accounts for about 17 per
cent. Since the 1990s, the average growth of manufacturing has been 7 per cent. With
7.5 per cent growth, manufacturing's share could rise to 20 per cent of GVA by
203031. If the growth rate of manufacturing can be raised to 10 per cent, the share of
manufacturing in gross value added can rise to 25 per cent, bringing India into striking
distance of becoming a global manufacturing hub with forward and backward linkages
for other sectors of the economy. To achieve this, India must adapt to the fourth
industrial revolution (automation; data exchange; cyber-physical systems, the Internet
of things; cloud computing; cognitive computing and creating the smart factory,
advanced robotics). In order to succeed as a manufacturing power, a skilled labour
force will hold the key.
India's manufacturing must find expression in global markets - make in India for the
world. A vibrant and diversified manufacturing base is essential for boosting India's
exports. Intensified efforts need to be made to raise India's exports of goods and
services from US$ 768 billion or 2.4 per cent of the world total to US$ 1 trillion each for
merchandise and service exports or 5 per cent of the global total by 2030. The potential
exists in the form of sectors such as IT and digital services, high value agricultural
products; high-value tourism; financial services; retail and e-commerce. India is
preparing for this export thrust through initiatives such as the production-linked
incentive scheme, districts as export hubs; and supporting the export potential of micro,
small and medium enterprises (MSMEs). Global Capability Centres (GCCs) set up in
India are already exploiting these innate strengths. They are already leveraging on
India's workforce, leading product innovation, driving technological advancements,
creating next-gen intellectual property (IP) and spearheading digitalisation initiatives.
As India emerges as an export powerhouse backed by a strong manufacturing base, a
natural corollary will be the full internationalisation of the Indian rupee. Several factors
are already in place. The Indian diaspora is the biggest in the world and India is the top
recipient of remittances. The Indian rupee trades three times more offshore than
onshore. India is expanding local currency settlement arrangements with several
countries in Asia and the middle east and interlinking of payment systems is underway.
Deep and liquid financial markets are developing. The international financial centre in
GIFT city, Gujarat is emerging as global financial and technology hub with a thriving
financial ecosystem. The policy emphasis on macroeconomic and financial stability is
also a positive for the INR going international.
The last challenge I will dwell upon is the greening of the Indian economy for
sustainable development. This involves managing climate change. Climate change is
overwhelming us, putting the planet and humanity at risk. It is manifesting itself at an
alarming scale and pace globally, undermining livelihoods, infrastructure, and
endangering health, food, energy, and water security. Climatic disasters are occurring
more frequently and across the globe. The year 2023 turned out to be the hottest ever.
In 2024, India is experiencing among its worst heatwaves and forest fires. Bengaluru is
facing a water crisis. Reservoirs are going dry. Australian and US weather agencies are
predicting floods in this monsoon season due to La Nina. We cannot be immune or
inactive any longer.
At the Conference of the Parties 26 (COP26) in 2021, India's commitment towards the
environment by 2030 has included: (i) 500 GW non-fossil energy capacity; (ii) energy
mix comprising 50 percent renewable energy; (iii) reducing total projected carbon
emissions by one billion tonnes; (iv) reducing the carbon intensity of its economy by
less than 45 percent; and (v) achieving net zero by 2070. It is estimated that a
cumulative investment of US$ 10.1 trillion is needed along with adequate access to
meet technological requirements.
Conclusion
Given the innate strengths I described and the resolve to achieve its aspirational goals,
it is possible to imagine India striking out into the next decade to become the second
largest economy in the world not by 2048, but by 2031 and the largest economy of the
world by 2060.
What is the role of monetary policy in this context? The principal task of monetary policy
is become the anchor of the Indian economy. Short-run fluctuations of aggregate
demand have to be managed pro-actively so that a broad alignment with the economy's
evolving productive capacity is ensured. Price stability is the best contribution that
monetary policy can make to strengthen the foundations of the aspired trajectory of
growth over the next few decades. The formation of inflation in India needs to be
navigated towards convergence with global inflation so that both the internal and
external value of the rupee is preserved. This will prepare the ground for the
internationalisation of the rupee and the emergence of India as the economic
powerhouse of the world of tomorrow.
Valuable comments received from Harendra Behera, Asish Thomas George, and
editorial help from Vineet Kumar Srivastava are gratefully acknowledged.
1
World Economic Forum 54th Annual Meeting; January 15, 2024.
2
Patra, M.D., Behera, S., Behera, H., Banerjee, S., Padhi, I. and Sood, S. (2024). The
Shape of Growth Compatible Fiscal Consolidation. RBI Bulletin, February.
3
Wheebox: India Skills Report 2024. https://wheebox.com/assets/pdf
/ISR_Report_2024.pdf