The Modi Government’s focus is on creating assets. With this, fiscal deficit will be under control and there will be no risk of banks’ money landing in pockets which could destabilise the economy and aggravate inflatio
For the sixth time in succession, Reserve Bank of India Governor Raghuram Rajan has refused to budge. In its monetary policy stance released early this month, the RBI has retained the repo rate (rate at which banks borrow from RBI) at eight per cent.
This is despite a retail inflation during November at 4.3 per cent (wholesale inflation has plunged to ‘zero’) already hovering at just half the eight per cent benchmark set by the RBI for January, 2015, below which, a cut in repo rate can be triggered.
This is also despite a fragile recovery in gross domestic product growth viz, 5.7 per cent during April-June; 5.3 per cent during July-September, and a decline in industrial growth by 4.2 per cent in October. All of which underscores the dire need for a booster dose.
And, this is despite Union Minister for Finance Arun Jaitley clearly spelling out his expectations from the RBI. While, revealing all that the Government is doing to boost growth and revive manufacturing sector, Mr Jaitley has also sought support from the RBI by way of rate cut. The RBI Governor has expressed satisfaction over developments on inflation front. Yet, he would like to see a declining trend in inflation to be — what he describes as — ‘deeply entrenched’ before one can expect him to release a brake on interest rate.
What is the connotation of ‘deeply entrenched’? Retail inflation has declined from 8.3 per cent in March to 4.3 per cent in November. During the same period, wholesale inflation has plummeted from 5.7 per cent to ‘zero’. If these numbers do not satisfy the test of ‘deeply entrenched’, then what else would do?
Already, the oil price has dropped from a high of $110 per barrel in June to a low of $60 per barrel currently. Further, the global scenario (depressed demand from the European Union and China, record supply from the US and increase in its shale gas production and no disruption from West Asia) is clear pointer to its price continuing its south journey. Even in agriculture, rainfall deficiency of only 13 per cent is unlikely to be discomforting for food output.
Mr Rajan also refers to the so-called ‘base effect’ to justify his stance. Put simply, it means that if the inflation, say, in November 2013, was high than in November 2014, then inflation which is measured as an increase over the former will be lower. This argument does not hold water when seen in the light of inflation during the current year remaining consistently low month-after-month.
The above, clearly points towards Mr Rajan 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 the 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, the demand for credit had been sluggish due to economic slow down and projects stuck in bureaucratic red-tape. The new Union Government has un-clogged these by putting approvals on fast track. In this backdrop, more funds at lower cost will help industry augment supplies and become cost-competitive.
A root cause for inflation was spiralling food inflation. Food inflation in turn, arises due to supply side bottlenecks. The Government has taken steps viz, release of food grain from central pool, de-listing fruit and vegetables from Agricultural Produce Market Committee Act, action against hoarders etc to overcome these constraints. While, these steps have led to a steep decline in food inflation in turn, lowering retail inflation, it is naive to presume that increased lending will fuel prices from demand side. The consumption of milk, meat, fruits and vegetables etc depends on needs, and no one will buy more just because one has extra money in one’s pocket.
The Modi Government’s sole focus is on creating assets, building infrastructure and directing subsidy/welfare money to bank accounts of poor, under Pradhan Mantri Jan Dhan Yojana. It is even restructuring 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 there will be no risk of bank money landing in pockets which could destabilise the 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.
The 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 the latter is affected more by a host of supply side factors (if today inflation is down, it is because those factors have been tackled). On the other hand, if the rate is still kept high, this will certain stifle growth.
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