In the second quarter policy review for 2012-13, announced by the Reserve Bank of India on October 30, the discord between North Block and Mint Street figured more prominently in the headlines than the policy moves.

The Finance Minister reportedly was not pleased, as he felt the central bank did not do enough to spur growth. Even the Deputy Chairman of Planning Commission reportedly commented that “We expected RBI to move to support growth revival.”

On its part, the RBI has reduced CRR by 25 basis points to 4.25 per cent effective from November 3, which is expected to inject primary liquidity of Rs 17,500 crore. If one considers the liquidity creation in subsequent rounds, there will be a manifold increase in loan supply.

At the minimum, this will enhance the credit creation capacity of the banks. A couple of months back, this is what the SBI Chairman had urged the RBI to do to facilitate credit expansion. How, then, can this move be interpreted as not being growth-inducing?

If the Government’s displeasure is related to the RBI increasing the provisions for restructured standard accounts by 75 basis points, it should understand that genuine financial stability concerns prompted such a move. It should respect the RBI’s judgment on this issue.

RBI’s superior foresight

This discord brings to mind a similar situation in 2006-08. The RBI adopted monetary tightening in view of signs of overheating, reflected in an unprecedented surge in credit flow and elevated equity prices. At that time, the Finance Ministry dubbed the RBI’s assessment as imaginary rather than real. Looking back, many realise that the RBI under Y. V. Reddy saved the country from a potential financial crisis, with its conservative approach to irrational exuberance in banking and finance.

On the contrary, some analysts attribute part of the inflation in recent years to excessive monetary accommodation in the run-up to the last general election. The pretext then was to thwart the fallouts of global financial crisis in the Indian context. Analysts believe that the situation was an outcome of North Block’s domination over RBI, with a new Governor at the helm at that time.

Going by the textbook, the central bank takes a longer term view of the economy, while the government is more concerned with immediate outcomes, more so with elections in mind.

projections and outcomes

The table compares RBI’s inflation projections as per the annual policy announced generally in April each year for the forthcoming financial year, and revised projections in the mid-term review (second quarter review in October/November), with actual outcomes.

It can be observed that whenever the RBI revised its inflation projection upwards in the mid-term/second quarter review, actual inflation was generally higher than the revised projection.

In one out of last eight years, actual inflation was lower than the revised level, and in another it was equal to the revised projection. It is possible that RBI underreports its true projections to anchor inflation expectations.

In the current review, inflation projection has been revised upwards to 7.5 per cent for 2012-13. Going by past experience, it is highly probable that actual inflation may overshoot 7.5 per cent, further skewing the growth-inflation equation.

A number of research studies have established that high inflation is inimical to economic growth. By emphasising calibrated monetary accommodation, RBI is acting with a great sense of responsibility — ensuring stable prices to promote growth.

The Finance Minister is not alone in facing the challenges of growth; the RBI is very much by his side.

(This article was published on November 2, 2012)
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