With the term of the incumbent RBI Governor Raghuram Rajan approaching its completion and the announcement of Urjit Patel as the next Governor, the dust has begun to settle. Past few months have seen an acrimonious relation between the RBI and the government over the trajectory of economic policy in India. At the heart of the matter lies the clash between the macroeconomic balance between economic growth and inflation. NDA-II came to power promising higher economic growth and job creation to usher in the proverbial “acche din”. Central to this plan is the revival of the manufacturing sector fueled by the domestic demand and also attempts to capture the export markets in the light of rising production costs in China.
And true to its promise, the new government has launched various schemes like Make in India, Start Up India, Stand Up India, Mudra Bank etc to give a flip to the manufacturing sector. It has also undertaken sweeping economic reforms to open up more sectors of the economy to the flow of foreign funds, making India one of the most open economies in the world today. It has been zealously pursuing infrastructure projects like Smart Cities, Dedicated Freight Corridors, revitalising the highways construction to lower the logistic costs in India. A major bottleneck for the manufacturing sector in India, it should be remembered, is the high logistic costs.
But all grand scheme may come to a naught if the interest rates in the economy do not come down. But the attempts to lower the interest rate has not found the desired favor with the RBI, which continues to focus on inflation as its main policy objective. It has resulted in a stand-off between the RBI and the government, which spilled over as the avoidable controversy over the issue of the second term to the Raghuram Rajan. But despite the missives of the government, RBI concerns are not far-fetched. Indian economy is still not out of the high inflation risk.
The latest data shows that the wholesale price inflation has risen to 3.55 percent in July from 1.62 percent in June, which is most rapid in the last 23 months. Worryingly, it is being led by the rising prices of both food and non-food articles. Not just this, the retail inflation has crossed the upper limit level of 6 percent set by the RBI in the July from under 5 percent in June. It has been driven by the rising food prices despite the above normal monsoon after the drought-like situation in the last two years.
Even though experts expect the food inflation to fall due to better monsoon, it shows that the inflationary pressures in the economy have not yet subsided. And therefore, any slip up in the monetary policy may cause an increase in the aggregate demand in the economy causing inflation to spiral up to politically unsustainable levels. Plus, there is always the uncertainty of the crude prices going up after a long period of favorable rate. The implementation of the recommendations of the 7th Pay Commission may further exacerbate inflationary pressures in the economy. Thus, despite the appointment of the new RBI Governor, it doesn’t seem that the basic clash between the RBI and the government would be resolved anytime soon.
Therefore, the actions of the new Governor will be perhaps the most important decision made by the RBI in the coming months. The task of Urjit Patel is by no means easy. He will be under tremendous pressure by the government to ease the monetary policy stance and cut the interest rate to boost the rate of economic growth. But he will also be faced with inflationary pressures, especially food inflation. The pressure form the government will continue to increase as 2019 approaches.
But India’s growth story faces another lurking menace. It is the dangerously high levels of Non-Performing Assets (NPAs) with the banks. It has not just made the banking system more fragile and prone to crisis, but has also severely limited the credit-growth necessary for economic growth. That a large portion of these NPAs come from the infrastructure sector does not auger well for the growth of the sector and may hamper the plans to boost industrial sector by providing better connectivity.
The plans for re-capitalisation of the public sector banks have been mooted but how far it would be successful will depend much on the synergy between the government and the new RBI Governor. But what is certain is that the grand plan of the NDA-II to revive the economic growth on the back of robust manufacturing sector growth is an uphill task, which will test all the skill and acumen of the government in the months to come. While the Chinese slowdown has opened up a brief window for India to replace China as the world’s factory, it is not certain yet whether that can actually happen.
(Dr.Sharad Ranjan is Associate Professor of Economics at Zakir Husain (Evening) College, University of Delhi. The views expressed are strictly personal.)