‘RBI is no cheerleader for economy’

Rate cuts should not be seen as goodies that the central bank gives out stingily after much public pleading, according to Reserve Bank of India Governor Raghuram Rajan.

Also, reiterated Rajan at FIBAC 2015, the annual FICCI-IBA Banking Conclave, here on Monday, the RBI is not a “cheerleader” for the economy.

“By this I do not mean that the RBI does not want to do its utmost to see the economy do well. Far from it!

“What I mean is that it is not the role of the central bank to elevate sentiments unduly, to deliver booster shots to the stock market so that it can soar for a while, only to collapse when reality hits.”

The RBI Governor further observed that one does not have to look too far beyond our borders to see the consequences of such ‘boosting’.

“What is important is sustained low inflation — something the Prime Minister emphasised in his Independence Day speech. And rate cuts are a natural consequence that the RBI has no hesitancy in delivering,” said Rajan.

Referring to the demand of stakeholders, especially industry, that since “inflation is low, you can now turn to stimulating growth”, the Governor explained that this also perhaps reflects a misunderstanding of how central banking works.

“Monetary policy works with a lag of three to four quarters. So, in deciding policy today, we need to predict how inflation will look approximately a year ahead. Today’s inflation therefore matters only in informing us about future inflation.

“However, today’s inflation measured on a year-on-year basis may be low because there was an unexpected price spurt last year — the so-called base effect. So we need to take out base effects before we even assess the information from current inflation, something many observers fail to do,” he explained.

Also, there may be many sources of uncertainty that cloud the future inflationary picture and disconnect it from current inflation — the strength and distribution of the monsoon, the extent and persistence of low commodity prices, the effect of external disturbances on the exchange rate, etc.

Volatile inflation Rajan felt that a policy that tracks current inflation, rather than anticipates future inflation, is inherently biased towards more volatile inflation, which is not in the public interest.

The best way the monetary authority can support growth over the medium term, according to him, is to anchor inflation at low levels so that policy rates can also be low.

“We can never abandon inflation to focus on growth, nor do we focus on inflation to the exclusion of growth. The extended glide path over which we are bringing inflation in check appropriately balances inflation and growth,” he said.

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