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The decline in the GDP growth rate for the last quarter of 2011-12 has been a jolt to policy honchos. The slowdown was only to be expected given the Consumer Price Index (CPI) inflation rate of 10.2 per cent Index), the wide balance of payments current account deficit (CAD) of 4 per cent of GDP, a depreciating rupee and hesitation of foreign capital to flow into India.
Above all, domestic political economy uncertainties are a negative factor dampening investment.
The Reserve Bank of India (RBI) is scheduled to undertake its mid-quarter review on June 18, and it is expected to produce a dues ex machina ( a God out of a machine) as a denouement for all our economic problems. India Inc. is articulating the need to ease monetary policy, stem the depreciation of the rupee, control inflation, facilitate growth, and the RBI is expected to deliver on all these counts.
The overarching role of the government in formulating the monetary policy is well known. In the recent period, however, the government has been publicly flaying the RBI and officials have been loquacious regarding the need for easing interest rates and pumping in liquidity. The coup de grace has been the recent public statement by the Finance Minister, Mr Pranab Mukherjee, laying the blame for the current slowdown at the doors of the RBI for its tight monetary policy.
In defence of RBI
Thirty years ago, the RBI undertook an unprecedented monetary tightening. For the first time, there was a Calling Attention Motion in the Rajya Sabha, in January-March 1982, on monetary policy, and the Opposition unleashed a savage attack on the RBI and, in particular, the then Governor, Dr I. G.Patel.
The Finance Minister undertook a brilliant defence of the RBI and its Governor and also made it clear that anything the Opposition wished to say should be directed to the government and not the RBI Governor.
It is imperative that today's policymakers and others participating in the debate read the Rajya Sabha proceedings. The then Finance Minister was none other than Mr Pranab Mukherjee.
Differing views
It is interesting that two Deputy Governors have, in the recent period, looked at key issues in monetary policy from different vantage points.
In policy matters, there is no single view and as part of transparency it is just as well that these views get aired in the open. Some observers argue that differing viewpoints give confusing signals to the market.
We all want greater transparency but we get concerned about differing views! Would a monolith party line be ideal for markets or should we have different views articulated freely?
The Deputy Governor, Dr Subir Gokarn, in a carefully crafted statement, said that the below trend line growth and fall in crude oil prices offer the RBI a window of opportunity to reduce interest rates, though he qualified it with the fact that there are pressures from food prices, depreciation of the rupee and fiscal pressures.
Stability matters too
The Deputy Governor, Mr K. C. Chakrabarty, in a bold statement said that the slowdown in GDP growth cannot be attributed to only high interest rates but also to a host of other factors.
It is indeed commendable that Dr Chakrabarty has clearly articulated that there are many factors other than interest rates accounting for the slowdown in growth.
He felt that the impact of interest rates on growth was being overplayed.
Reputed pundits have been pronouncing that stability matters, not just inflation and that the RBI should reduce policy interests and infuse liquidity. Generally, interest costs account for 10 per cent of total costs. Let us look at an industry which is bank-credit intensive and say, interest costs account for 20 per cent of total costs.
If policy interest rates are reduced by 0.50 percentage point, the reduction in total costs would be of the order of 0.1 percentage point. Reducing interest rates and injecting liquidity would merely increase inflation.
The CPI increase of 10 per cent should be a flash signal to tighten monetary policy.
It needs to be appreciated that the world over inflation indices are understated. With the current Indian CPI inflation of 10 per cent ,the actual or “true” inflation rate could possibly be 15 per cent.
We would no doubt be reminded that China has just reduced interest rates (never mind that this is the first reduction since 2008).
Resist policy easing
What would be the appropriate monetary policy response on June 18. Given the current inflation rate and the wide CAD and further likely depreciation of the rupee and the hesitation of investors to move funds to India, the ideal policy would be to raise policy interest rates and increase the cash reserve ratio.
Given the diktat from North Block to ease monetary policy, the RBI would be performing its duty if it engages in a battle of attrition as Dr Chakrabarty has competently done. At the least, the RBI should strongly resist any policy easing on June 18.
The RBI Governor, Dr Subbarao's task is not enviable and the RBI needs public support and understanding so that it is not made the favourite whipping boy of the government.
(The author is an economist. >blfeedback@thehindu.co.in
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