Let RBI take charge

As the latest inflation print was released last week, the chief economic adviser, Arvind Subramaniam, had asked for an interest cut, criticising the RBI of committing errors in predicting inflation path. Later, as the Index of Industrial Production (IIP) was given out, and it showed a drop in industrial growth, the demand became more strident. And finally, as the stock market touched new highs, there was renewed demand for an interest cut to support the corporate sector and contribute to the continuing party.

If the Central bank is pliable and cuts interest rates every time it is demanded, soon enough it would reach a point when it cannot possibly cut interest rates any further. Indeed, something of this kind has already happened; fortunately, not in this country, but elsewhere in the developed economies. US, EU, and Japan all had cut interest rates in the hope that it will jack up economic activity. When their economies did not respond to that stimulus enough, they went into negative territory, that is when you have to pay a small percentage for holding money with the bank or the Central bank. Then, it was realised that, after all, negative interest rates were not such a bright idea.

Interest rates have been bones of contention since some time. P Chidambaram, as Finance Minister, had a running battle with then RBI Governor, PV Subba Rao, over interest cut, just because the overbearing minister had thought any cut would automatically and instantaneously push overall growth rate thereby adding feathers to his already bloated cap. Fortunately, we had a RBI Governor who refused to comply and was even ready to join the war of words.

All that aside, do the figures really merit an interest cut just now? Setting monetary policy, interest rate being a primary tool for that, is a complex job which has to take into account a slew of priorities. For the Central bank, the first priority is price stability, and all its actions are to be judged against that single and overarching consideration. Thereafter, you can think of a Central bank as one of the institutions which promote growth and stability of an economy.

Seeing the current situation from that primary concern regarding price stability- should RBI cut its interest rate now? The Central bank has been tasked with inflation targets by the government and that target now appears to have been undershot. Current inflation rate is a little less than the targeted level. But should the policy rates be cut immediately if it is less than the target? Doesn't it merit some caution?

It looks as though it does. If you look into the fine print of the inflation figures, the rate is low because of the very low inflation rate in food articles. This behaviour of the food prices is rather uncommon. Year after year, food prices had shown rising trend at this time, during the summer till October harvest. This is reasonable because the availability of food items –particularly vegetables and fruits—go down. This time it is somewhat different and prices have been stable to low. Some items have fallen as supplies have jumped.

However, this is more due to temporary over-supply than a secular rise in production. More so, we have to wait for the overall behaviour of the monsoon which will determine the crop, the harvest and thereby the prices. So a re-look at the policy interest rates should be taken a little later when the monsoon has progressed, as there is some clear idea of the trends in cropping and possible production. The real issue will be to check how much of that production really comes to the market, rather than getting rotten.

Meanwhile, what should be taken care of now is how much stocking facilities are around, as, in the absence of that, crops generally go to waste. We have only recently witnessed how farmers had committed suicide following a crash in prices of their crops (mainly vegetables and some food grains). The sad incidents gave rise to demands for bank loan waivers for farmers, which was the wrong move. Instead, it was important to drive home the point that there is a need for cold storages and reefer vehicles for reaching the harvest fresh to the consumers.

These are important practical considerations. A hasty decision would exhaust the RBI's options for making the correct move at the right time.

As for interest rate policy, employment, and inflation levels, there are rather free and casual mentions in the popular discussions –particularly on TV programmes—of complex concepts such as the "Philips Curve". The concept is loosely being used to refer to a possible trade-off between employment and inflation rate. However, it has not been realised that this holds true only in very strict conditions where there are limits on production rise, among others. In a way, this should not apply to an economy like that of India, where production rise is not a constraint.

In one popular discussion, even the changes in the methodology of national income computation were cited as a reason for doubting the GDP figures. However, there would be no elaboration of why the changed methodology was showing an untrue GDP picture. These are verging on the presumptuous. As little of the nuances of professional statisticians or technical economists are really factored into these deliberations.

One can only say that the monetary policy is best left to RBI. They have enough expertise and one can refer to these from a very broad public affairs standpoint.