Millennium Post

Rajan walks the tightrope

Reserve Bank of India governor Raghuram Rajan has lived up to his reputation. He had forewarned about the impending global financial crisis in a conference in Jackson Hole where world’s central bankers and economists had congregated at the high noon of Great Moderation period. Everything was in the best of shape, global economy was growing and financial markets were scaling new heights. Alan Greenspan was reigning at the US Federal Reserve with his approach of light touch regulation. Amidst all this euphoria, Rajan had spoken of the risks to the system and possible crash.

Today in a different context and on a far smaller scale, he has shown his capacity for fresh thinking. When the community of economists and analysts were all unanimous that RBI will come out with yet another dose of interest rate hike in the face of the latest inflation numbers, Rajan had decided to keep interest rates unchanged. This was the difference between a confident economist and
copybook economics. Conventional economics invariably says that jack up interest rates when inflation is high. This should put squeeze on demand and thus prices should come down. This logic was scrupulously being followed for last five years with consecutive rate hikes in the face of rising inflation releases. It was clear that the rate hikes were proving to be futile in checking the inflation we were having.

After all, the core inflation, that is, rate of price rise of non-food manufactured goods, had come down to levels which were lower than the RBI expectations. At around two per cent the manufactured goods inflation was rather low for comfort. Any further slowing down of inflation rate for manufactured goods would have been tantamount of deflation, which is worse than inflation.

However, the food prices were on the romp. These were rising as if there was no end to it. Onion prices were rising for months on end by between 200 per cent and more on year to year basis.

Potato prices were similarly rising, while of course occasionally collapsing. Even rice and wheat prices were rising by as much as 20 per cent which was surprising given the large public buffer stocks of major food grains. In his review and assessment, Rajan had underlined as much. He noted that current inflation is mainly due to rise in food particles prices. He had also stated that the retail inflation (that is, Consumer Price Index) was ‘unacceptably’ high. Wholesale inflation has also been high and yet slowly rising.

In the face of these facts, Rajan had refused to be cowed down and desisted from rate hike – the most convenient option for the central banker. Instead, he has taken a policy decision which he chose to describe as ‘a close one’. What are the reasons for taking such a close call.

First, although current level of inflation is high, there is what RBI has cited as ‘wide bands of uncertainty surrounding the short term path of inflation’. Otherwise, thre RBI is as much worried about high inflation as it reasonably expects short term inflation to ease from now on. Given the fact that both CPI and WPI has been driven by upsurge in food inflation, with pointed shooting prices of vegetables, fruits and food grains, there is some expectation that from now on, prices of food articles might possibly come down. This is reasonable because at least vegetables and fruits, onion and potato prices have shown a tendency to fall in the winter months when production and arrival of these items are higher. Sometimes in many years these prices had collapsed as with too much supplies in the market, with very little storage facilities, these prices have gone down sharply.

If that happens, then there should hardly any use raising rates just now. A call on rate hike could be taken later just as well. The statement hints to that effect and asserts that any intervention might come any time, even in between monetary policy reviews schedule. So RBI is keen not to ‘over-react’ to the situation and give growth a fighting chance.

Secondly, it has justifiably taken note of the fragile state of the domestic economy. After all, the industrial sector has remained bogged down and production has mostly remained flat, if not contracting. National income growth has come mainly from rising production nin the farm sector and some growth in the services. The absence pf vibrant industrial sector will ultimately bring down growth rates much further. This inevitably results in loss of opportunities for creating fresh employment and demand.

Rajan has shown his concern for growth and more particularly to ground level situation of Indian industry. If India has to grow at a faster clip, then industry must be the engine for that. Because industrial growth generates demand for faster services growth. In formulating his credit policy stance Rajan has shown that while all central bankers are primarily concerned about prices, monetary policy in a developing economy need not be a close print of those in developed economies.

Rajan has shown the role and stance of monetary policy in a developing economy and hopefully he should continue with his fresh thinking.

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