‘Govts have to focus on fighting inflation now'

Central bankers' job is not to maximise the growth or profits of the corporate sector. They should ensure that the monetary conditions in the economy are such that inflation is under control. And that's a forward looking exercise. “In some sense, we don't care what happened in November, December or January because we can't influence that. We are looking ahead to the end of this year – where's growth going to be, what are my monetary settings, where do I think inflation is going to be,” says Mr Paul Gruenwald, Chief Economist for Asia at Australia & New Zealand Banking Group Ltd. Excerpts from the interview to Business Line.

What are the prospects for economic growth, globally and in Asia, and specifically India?

Asia is leading the global recovery. I think the US is starting to look a bit better, but there's still a long way to go. We have the labour market, the housing market, the bloated US Government balance sheet; but that's a multi-year process. In Europe, the challenge is working through this big mountain of debt. The Governments spend too much money, there's too much debt, which ultimately has to be restructured.

Asia does not have any of these problems. If look at Asia and particularly India, household balance sheets look strong. No one is suffering from the overhang of the US housing bust. Banks seem to be in pretty good shape across the region. Asian banks, including Australian banks, had almost no exposure to the sub-prime market in the US. Governments took the pre-crisis boom years to pay down their debts, so public balance sheets are pretty strong. India on this front is probably on the weaker side in the region. Corporate balance sheets across Asia too look pretty strong.

Inflation is the big issue right now globally, with the World Bank recently issuing its warning. What are your views on this issue?

We have flagged inflation as the number one risk this year. Late last year we were still deciding whether growth was on a solid footing. So we were asking the question to ourselves and to our clients whether Governments should continue to support recovery or start fighting emerging inflation pressures. We realised fighting inflation is what they should be doing. We've been watching inflation very closely over the last couple of months. So what started as food and fuel inflation, which is largely out of control of policy makers, has started to creep into general inflation. Now that doesn't happen automatically, I think that's happening because monetary settings across Asia are still too loose.

Do you suggest tighter monetary policy?

If we were back to the neutral policy settings or even a little bit on the restrictive side because the growth is strong and recovery is complete, we may not necessarily have a spillover from food to non-food inflation. If we look across Asia, we have had a lot of policy loosening (stimulus) since early 2009 and a lot of countries have since been very relaxed in bringing it back to neutral. I think India, along with China, is at the forefront of bringing it back to neutral. But if you look at other countries in S.E. Asia and I would include Korea, they have been winding up stimulus at a very modest pace. I think it should pick up the speed. Because inflation is getting broad-based and this is going to be another year of good growth, no one's forecasting a slowdown. This means that we have to get back to a neutral monetary stance, if not tighter money policy.

Is monetary policy the only instrument to fight inflation?

Monetary policy is just one of the instruments. We can also go in for fiscal consolidation which would cool off the demand pressures in the economy. For some of the smaller, open economies in the region we can use the exchange rate. One thing we saw last year and I didn't see many analysts picking that up, we have three-four countries in the region, some of the smaller ones, they really let their exchange rates strengthen. These would include Malaysia, Thailand, Taiwan and Singapore. Their exchange rates hardened by 8-10 per cent last year and these countries did not wait for China to move. I think policy makers have been pretty eclectic. So it should be a mix of interest rates, exchange rates, fiscal tightening, capital controls, etc. I think the tool kit that is being used is not being used fast enough.

Maintaining the balance between growth and inflation has always been a challenge for the Reserve Bank of India and other central banks. Is there a risk of growth getting choked ?

Well, central bankers are not supposed to be popular. So what the RBI should be doing (and it is already doing a good job of that) is to make sure that the monetary conditions are such that inflation is under control. And that's a forward looking exercise. In some sense we don't care what happened in November, December or January because we can't influence that. We're looking ahead to the end of this year – where's growth going to be, what are my monetary settings, where do I think inflation is going to be. The RBI's job is not to maximise growth or profits of the corporate sector. Of course, corporates want cheap exchange rates and low interest rates so that they can grow fast. But the central banks are looking at the macro picture. In the short term, central bankers may seem unpopular, but in the long run if inflation is under control and on a stable path, you're setting the ground for stable growth with less volatility in the economy, which in the case of India is around 8 per cent, which is what the RBI is doing.

But food inflation in India is also being fuelled by other structural, supply side factors?

That's right, but there's not much central banks can do to ease supply side pressures. Central banks' job is to try to control only the demand side. So if you see a supply shock whether it food or fuel or whatever, central banking best practices suggest that you're supposed to look through that into the second hand effect. So central banks must make sure that the monetary settings are correct, to make sure that the inflation does not spread to other sectors.

How do you see the recent unrest in West Asia affecting the economies of Asia?

Basically we are looking at potential disruption of fuel supplies and there's not much policy makers can do, when we look at economies across Asia. If there is a spike we will have to see which countries in the region have large weights on fuel, and what the central banks should be doing. Then again we don't automatically react to that unless it's going to feed into broader inflation. We may have to live with higher inflation for the time being and central banks should communicate to the markets that it is a supply side phenomenon and there's not a much they can do about it.

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