For the sixth time in succession, RBI Governor, Raghuram Rajan has refused to budge. In its monetary policy stance released early this month, RBI has retained the repo rate (rate at which banks borrow from RBI) at 8%.
This is despite retail inflation during November, 2014 at 4.3% (whole sale inflation has plunged to ‘zero’) already hovering at just half the 8% benchmark set by RBI for January, 2015, below which cut in repo rate can be triggered.
This is also despite fragile recovery in GDP growth viz., 5.7% during April-June, 2014; 5.3% during July-September, 2014 and decline in industrial growth by 4.2% in October, 2014, all of which underscores dire need for a booster dose.
And, this is despite finance minister Arun Jaitely spelling out his expectations from RBI in unambiguous terms. While, revealing all that government is doing to boost growth and revive manufacturing sector, he has sought support from RBI.
Governor has expressed satisfaction over developments on the inflation front. Yet, he would like to see declining trend in inflation to be – what he describes as – ‘deeply entrenched’ before one can expect him to release brake on interest rate.
What is the connotation of ‘deeply entrenched’? Retail inflation has declined from 8.3% in March, 2014 to 4.3% in November, 2014. During the same period, whole sale inflation has plummeted from 5.7% to ‘Zero’. If these numbers do not satisfy the test of ‘deeply entrenched’ then, what else would do?
Rajan alludes to possibility of a rate cut in next review. This is reminiscent of similar allusions made in previous policy stances but, outcome was disappointing. So, any indication now that rate will be cut does not inspire confidence.
There are other reasons that make one suspect whether he will switch gear at all. Thus, he believes that moving forward, there could be an upside risk to build up of ‘inflationary expectations’. This may be triggered by up turn in oil prices or decline in food production, he argued. The facts speak otherwise.
Already, oil price has dipped from a high of US$ 110 per barrel in June, 2014 to a low of US$ 60 per barrel currently. Further, global scenario (depressed demand from EU and China, record supply from USA & increase in its shale gas production and no disruption from west Asia) is clear pointer to its price continuing its south-ward journey. Even in agriculture, rainfall deficiency of only 13% is unlikely to be discomforting for food output.
Rajan also refers to the so called ‘base effect’ to justify his stance. Put simply, it means that if inflation rate say in November, 2013 was high then, in November, 2014 inflation which is measured as increase over the former will be lower. This argument does not hold water when seen in the light of inflation during current year remaining consistently low month-after-month.
The above clearly points towards Governor having a pre-meditated mind-set that “I shall keep a tight leash on interest rate come what may”. And, having decided that way, he looks for possible explanations. This brings us to a very basic question.
Why is RBI’s outlook towards inflation-interest rate linkage so stubborn and regimented? What makes it feel that flow of more money – consequent to lowering of interest – will exacerbate inflation? The apprehension is totally unwarranted.
Thus far, demand for credit has been sluggish, courtesy economic slow down and projects stuck in bureaucratic red-tape and cumbersome procedures under erstwhile UPA regime. The new government has un-clogged these by putting approvals on fast track. If interest rate is reduced, this will help industry set up projects at low cost and boost growth.
A root cause for inflation was spiraling food inflation. Food inflation in turn, arises due to supply side bottlenecks. Government has taken steps viz., release of food grain from central pool, de-listing fruit & vegetables from APMC Act, action against hoarders etc to overcome these constraints.
While, these steps have led to steep decline in food inflation (and has contributed to respite in retail inflation), it is naive to presume that increased lending will fuel prices from demand side. Consumption of milk, meat, fruits & vegetables etc depends on needs and no one will buy more just because he has extra money in his pocket.
The other cause in the past had been government’s unfettered fiscal profligacy. UPA-II in particular, indulged in reckless spending on welfare schemes and ballooning subsidies adding to trillions of rupees. A huge slice of these humongous funds did not even reach those for whom these were meant.
RBI abetted this profligacy by providing full support to government’s borrowing program. That left less money for productive activities. And, whatever came was at higher cost. Rising NPAs – a good slice of this are dues from ‘wilful’ defaulters – and Government’s lenient attitude towards them aggravated woes of genuine investors. But, that era is gone.
Modi-government’s sole focus is on creating assets, building infrastructure and directing subsidy/welfare money to bank accounts of poor under PM Jan Dhan Yojna. It is even restructuring MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) to create assets in agriculture/rural areas and restrict coverage only to low income states.
With this, fiscal deficit will be under control and no risk of bank money landing in pockets which can destabilize economy and aggravate inflation. Access to bank funds at lower interest rate will help setting up new projects, capacity expansion, building infrastructure and spurring growth in a cost effective manner.
RBI needs to get out of a syndrome that uses interest rate to combat inflation as there is no straight co-relation between the two. Whether or not high interest rate will tame inflation is uncertain as latter is affected more by a host of supply side factors. However, it is certain that it will scuttle growth.
The apex bank needs to shed its stubbornness and galvanize monetary and credit policy to complement government’s efforts in spurring growth. Hope, in the next review, Rajan will take a call on lowering the policy rate.