Millennium Post

Centre and RBI must join hands

The reassuring remarks made by the Union Finance Minister Arun Jaitley on March 22,stating that everything is honky-dory between the Ministry of Finance and the Reserve Bank of India (RBI), inadvertently implied that the mutual relationship continues to be tense. The denial of ‘disconnect’ between the two institutions said this in ample measure! Though the Governor of the central bank is chosen and appointed by the government, with past precedents showing that by and large they seldom embarrassed their benefactor, there were occasions in the past when some had chosen not to go in tandem with the government in following loose monetary policy when the authorities showed predilection for loose fiscal policy.

In fact, during the two tenures of the UPA government, the then Finance Minister Mr. P. Chidambaram had to concede that he would have to walk alone on the path of growth if the apex bank was reluctant to go along with him, by following an accommodating monetary policy ;i.e. softening the monetary policy rates. When things went out of control in the summer of May 2012, with the abrupt announcement of a likely exit of quantitative easing; in other words what economists had dubbed unconventional monetary policy by the U.S Federal Reserve Chairman Ben Bernanke, all hell broke loose in emerging economies; with India suffering the worst in terms of flight of capital, volatile exchange rate and a perilous spike in the current account deficit. It was at this juncture, that the UPA government sent its Chief Economic Adviser, Dr. Raghuram G Rajan to Mint Street in Mumbai to preside over the affairs of the country’s central bank-the Reserve Bank of India (RBI). What he did in subsequent, post his appointment went into the economic history books of this country, with the Indian economy ably steered back to normalcy.

Incidentally, Rajan himself acknowledged the gravitas and the greatness of the institution he had been chosen to helm, at the First State Bank ‘Banking and Economic Conclave’ in Mumbai in June17, 2014. He stated that “the RBI, despite the general deterioration in the probity of public institutions, has maintained a reputation for integrity” and must perforce have to “work on maintaining a culture, as well as service conditions, that encourage integrity”. This frank assessment about an 80-year old institution, that he had only taken over recently needs to be seen in a historical context: the apex bank’s well-earned functional autonomy and independence down the decades is the result of being ably steered by many distinguished helmsmen like Rajan.

Be that as it may, there are two areas on which most of the issues of differences in perceptions seem to be assailing both the Ministry of Finance and the RBI. Recently a momentous agreement on Monetary Policy Framework (MPF) has been signed between the apex bank and the Ministry of Finance, committing the RBI to bring inflation below 6 per cent by January 2016; with a target of 4 per cent with a band of plus/minus 2 per cent for 2016-17 and all the ensuing years. The accord also provides for the constitution of a Monetary Policy Committee (MPC) as in the United Kingdom and other European Countries, this committee will be tasked with setting the monetary policy, instead of the extant practice where the RBI Governor and his deputies set the monetary policy; after taking due account of all the factors that operate in the economy. Reports are rife that there are differences with the government over the formation of the MPC with both of them not on the same page over the precise nature and composition of the proposed Committee. It needs to be noted that this major pact of binding the government to a monetary strategy through inflation-setting follows a universal trend at other major central banks.

Here a caveat is in order. Most of the developed economies which embraced inflation-targeting two decades ago were at their wits’ end in recent years as inflation rate and interest rates were in the negative zone or on the wane, in the wake of quantitative easing that flooded economies with cheap money flow, making a travesty of any attempt at targeting inflation; with too much money chasing few takers resulting in asset booms which triggered undesirable consequences.

The emerging economy of Brazil has continuously missed its midpoint inflation target of 4.5 per cent for two years, thanks to a distinct lack of fiscal discipline. India has several unenviable parallels with Brazil on this score as the authorities have not shown any seriousness in quality fiscal consolidation up till now and the primary objective seems to be stoking public investment and public demand, the implied consequences of which, especially on inflation is too visible to be vaporized by the wishful-thinking that a growth-crazy government is keen on persisting with out of sheer compulsion. The onus on delivering inflation target on the apex bank alone is disproportionate to the clout and heft of the apex bank.

The authorities in the saddle should not swerve from the quality fiscal consolidation path, in order to bring a measure of stability to the fundamentals of the economy and the proper macro-economic milieu to ensure non-inflationary quality growth. Between the Congress penchant for inclusive growth through imprudent spending on welfare policies without ensuring the wherewithal to fund the spend and the BJP-led NDA’s façade of fiscal responsibility by spending on infrastructure, the bottom line remains that the central bank has to be vigilant about any vulnerability to the larger financial stability. Leaving aside this vital issue, the composition and voting rights or veto power to the RBI governor are equally thorny issues where both the parties would not like to cede ground-particularly the political leadership which has the indispensable remit to run the economy while the institutional regulator has only the dispensable moral authority!

On the issue of carving out a separate Public Debt Management Agency (PDMA), the RBI Governor appears to have yielded ground albeit with a qualifier in place, he stated that “a public debt management agency as a professional organization, independent of the central bank, independent of the government, is something that is desirable”. RBI had reconciled itself to abrogating its public debt management remit because of the dichotomy in that role: as the government’s sole debt manager it had to ensure money could be raised at low interest rates, whereas as a central bank, battling inflation in a permanently supply-constrained nation, it is compelled to increase interest rates. This dichotomy was too difficult to sustain any longer.

All said and done, despite Jaitley’s supposedly ‘candid’ confession that there is no “disconnect” with the apex bank over the recent functional overhauls, the need of the hour is for both institutions to respect each other’s functional space, keeping in mind the best interests of running the world’s third largest economy. IPA
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