More tokenism

By conventional logic , the Reserve Bank of India (RBI) has done the right thing by not succumbing to pressure from industry and even the Government to cut its benchmark interest rates in its latest quarterly monetary policy review. With annual wholesale inflation at 7.8 per cent in September – that too on a high ‘base’ of 10 per cent for the same month of last year – and the effects of a weak rupee and the recent fuel price increases yet to be fully passed-through to the wider economy, lowering interest rates now would have signalled its helplessness in containing inflation. That, in turn, would have badly dented its credibility as an institution– in marked contrast to the Government’s overall poor record of fiscal discipline – committed to its primary objective of “containing inflation and anchoring inflation expectations”.

While not conveying an impression of helplessness and the consequent loss of credibility are important, these need to also be tempered by a sense of realism over the limits of monetary policy in battling inflation. High interest rates cannot control food prices beyond a point, whereas they can help moderate manufacturing inflation by compressing overall demand in the economy. But this makes sense only when the economy is growing at a pace where it is prone to overheating – in which case, interest rate hikes are a potent tool. Today though, we are in an environment where growth has already slowed down. Leave alone fresh investments, even existing industries are struggling to operate to optimal capacities. The poor are hurt mainly by high food prices, which they can, however, absorb through higher incomes in a growing economy. But when growth slows down and food prices remain as they are – in spite of RBI’s tight money policy – they get hurt even more. And that possibility goes up further, when demand compression from high interest rates affects manufacturing growth and employment.

Recognition of these nuanced realities does not, by any means, amount to the RBI losing or the Finance Ministry gaining. Neither monetary nor fiscal policy can have fixed objectives at all times. Today’s circumstances require lower interest rates to stimulate overall demand, alongside fiscal consolidation emphasising a redirection of government expenditures away from consumption to investment. What we are seeing, instead, is a holier-than-thou RBI and a Government, whose recent policy reform pronouncements – including the Finance Minister’s ambitious five-year fiscal correction roadmap unveiled on Monday – are subject to political uncertainties as parties gear up for a long election season till May 2014. The loser from this absence of a coordinated policy response to a deepening growth slowdown would be those suffering loss of incomes amid persistent inflationary pressures.

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