The Hindu Business Line : Inflation heading down, but should RBI cut?

If there is one quality that a modern central banker needs, it is the willingness to abandon dogma. And monetary policy is much more than knee-jerk reactions to weekly inflation numbers.

S. Balakrishnan

It’s all over bar the shouting. Mr Duvvuri Subba Rao, Finance Secretary to the Government of India, will succeed Dr Y. V. Reddy as Governor of the RBI, ending weeks of suspense.

It can come as no surprise. The post of Finance Secretary is invariably a stepping stone to the Governorship — in fact, an asset, as the Government and the central bank must work together in shaping policy. So the new Governor is no stranger to his new job.

Having a civil servant — which Mr Subba Rao is — has other advantages as well. Generally, they have no rigid ideological position on monetary policy, i.e., no blind adherence to monetarism.

It is as it should be. Economics, as a subject, has not evolved to the level where given actions automatically result in predictable and desirable consequences.

Policy making is not easy, given the trade-offs (and one is not talking here of just the growth-inflation one). If there is one quality that a modern central banker needs, it is the willingness to abandon dogma.

Countervailing force

Mr Alan Greenspan and, now, Mr Ben Bernanke, the previous and the current Chairmen of the US Federal Reserve, have demonstrated how important it is for central banks to be a countervailing force in troubled times — never mind if it is contrary to conventional wisdom.

Governor Subba Rao, one feels, will not be hostage to any theory or school in his approach and decision-making.

The new RBI chief assumes office at a time when inflation dominates the headlines. His predecessor, Dr Reddy, reacted with successive liquidity-restricting CRR increases and repo rate hikes.

But the price index continues to rise. Do we need more of the same medicine or is there a (less painful) alternative?

Tough questions

This is the first difficult question confronting the new Governor the moment he assumes office. One bit of data might encourage him to stay policy. Banks have turned net borrowers from the RBI. Money market rates are in the neighbourhood of the repo rate. The CRR bites seem to be working.

The global environment is slowly turning favourable. Oil is well off its peak as are metal and agri commodities. Excellent harvests are in the pipeline, not only in India, but also the US, Australia and Canada, the principal food-growing nations of the world, putting the lid on food inflation.

The combination of falling prices and monetary measures beginning to bite may well see the price index dropping sharply in the coming months. That may not (and should not) translate into equivalent rate cuts. The current profile of benchmark and market interest rates is hardly anti-growth.

Monetary policy is much more than knee-jerk reactions to weekly inflation numbers.

balakris@vsnl.com

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