The Reserve Bank is off target: Pulapre Balakrishnan

The Resreve Bank is off the target: Pulapre Balakrishnan

This article published in The Hindu on August 1, 2017 raises certain basic issues relating to RBI's role in Monetary Policy management. Copied below is my article on the same subject published in July 2015 issue of The Global ANALYST. Perceptions differ. 

M G Warrier

Monetary Policy Management : RBI Takes Control*
M G Warrier

“If I cut interest rates, it means I want to please the government. If I don’t cut interest rates, it is because I want to have a fight with the government. Make up your mind.”
RBI Governor

RBI Governor Dr Raghuram G Rajan is an excellent communicator. He never minces words while expressing his views on matters he considers relevant to India’s economic growth and financial health. Celebrated economists and analysts are slowly reconciling to the fact that the present RBI Governor cannot be caged easily. Rajan’s awareness about the history and role of the Indian central bank allows him to take on those who try to preach about the contours of monetary policy or the need for RBI to respect the owner’s(read central government’s) wishes while operationalizing RBI’s policy stances on crucial issues. On June 2, responding to a query on recent measures to keep rupee stable in value and GOI view on the subject, Governor reportedly said: “There are all kinds of people in the government. Some who want rupee to be weak and some who want rupee to be strong.” Such divergences in views between ministries and among bureaucrats and economists belonging to different schools of thought are natural. In Kerala, for example the Excise Minister, the Finance Minister and the Social welfare Minister hold three different views on prohibition.
In such situations, the role of other wings in the system, like judiciary, regulatory and supervisory bodies and law enforcement agencies become more relevant. RBI has been traditionally playing an advisory role which goes a little beyond the mandated responsibilities. GOI has all along accepted and respected this position and therefore maintained a relationship with the central bank to ensure that the finance ministry guided by the political leadership works in tandem with RBI which decides the monetary policy in the context of ground level realities.
Clarity in policy perceptions
Within months after moving to Mint Road, Dr Rajan had come out with his perceptions about RBI's developmental role and in a speech during October 2013, explaining what the Reserve Bank was doing to improve the financial system, moved on to give broad contours within which the central bank planned to build the Reserve Bank’s developmental measures over the subsequent few quarters. He intended to base the policy concept on the following five pillars:
1.     Clarifying and strengthening the monetary policy framework.
2.     Strengthening banking structure through new entry, branch expansion, encouraging new varieties of banks, and moving foreign banks into better regulated organisational forms.
3.     Broadening and deepening financial markets and increasing their liquidity and resilience so that they can help allocate and absorb the risks entailed in financing India’s growth.
4.     Expanding access to finance to small and medium enterprises, the unorganised sector, the poor, and remote and underserved areas of the country through technology, new business practices, and new organisational structures; that is, we need financial inclusion.
5.     Improving the system’s ability to deal with corporate distress and financial institution distress by strengthening real and financial restructuring as well as debt recovery.
Recalled this to emphasize the wider areas of concerns the RBI is mandated to address, beyond ‘base rates’, inflation and the liquidity of the banking system. Let us also give credit to RBI for having initiated action on each of the five areas of concern mentioned above, during the twenty months that followed.
Till recently, many including this writer alleged that RBI’s Monetary Policy is a ‘caged’ one, referring to the postures taken by successive Finance Ministers, which pre-empted the central bank’s maneuverability. Things are changing. Though, the inflation targeting and certain other moves to truncate RBI may give an impression that slowly RBI’s role in India growth story and development economics or the several non-traditional roles the bank had taken on itself for historic reasons will get diluted, as of now such an eventuality is not too close.
Base rates management
“RBI is not a cheerleader. There are other people in the economy who can play that role. Our job is to give people confidence in the value of the rupee, in prospects of inflation, and having established that confidence, create the longer- term framework for good decisions to be made.”
Dr Raghuram G Rajan
RBI has many more worthwhile things to do and the ‘rate cut’ or managing base interest rates is just one tool in the central bank’s armory. Experience has shown that markets (read banks) are slow in responding to rate cuts by RBI while when the rates are enhanced, the percolation to the ground level is much faster. RBI’s rate cuts are more often reflected in reduction of deposit rates which reduces the purchasing power, though policy makers expect reduction in lending rates resulting in reduced cost of production and consequent softening of prices.
Talking to media, after the Monetary Policy Review on June 2, 2015, RBI Governor acknowledged that the aggregate 75 basis point reduction in repo rate so far has reflected in the commercial paper and certificates of deposit markets and actually bank fixed deposit rates have come down from nine per cent to eight per cent. Passing on to the lending side the full benefits of the rate cuts has always been slower.
Defending RBI action (cutting the base rate by 25 basis points and not going for a higher rate cut) Dr Rajan has made the following observations:
·        RBI has based its decision on future inflation rates as perceived by the central bank on the basis of available hard data. In a specific context he explained it(management of base rates) is an art, not a science.
·        Effort to bring inflation down is aimed at finally having a lower nominal interest rate. This was not the first time RBI is attempting this. It was done during Dr Rangarajan’s time when RBI created the environment for 8-9 years of strong, sustained growth.
·        Today, the rest of the world is in deflation. We have very high inflation, and as a result, we cannot bring normal interest rates down.
·        It would be silly to miss the inflation objective. It would imply a tremendous loss of credibility.
·        Political leadership is also worried about ‘mehangai’(rise in prices) and that is about inflation!

Appreciating RBI Governor’s position

When Mythili Bhusnurmath made a point that his action was dovish, but his statement was hawkish (Economic Times interview, June 4) RBI Governor had this to say:
“You are asking me to balance two things-inflation and growth ** ** If I think inflation is going to go up to 6% and there are risks because of monsoon, I say it clearly. On Tuesday(June 2), the IMD made a forecast foronly 88% rainfall. The country would have been much happier, sentiments would be stronger if IMD said it would be a normal monsoon. But the question is, do you want them to do that?”
S S Tarapore’s  concluding observations with reference to the June 2 Monetary policy Review, in his regular column in The Hindu Business Line(June 12, 2015) should be comforting to Dr Rajan. He said:
“Monetary policy should be allowed to deliver on what it is best suited to do, namely inflation control.
While facing brickbats for obviously right policies, Governor Rajan could take solace in the famous statement by Montagu Norman, the longest serving Governor of the Bank of England: ‘Dogs may bark, but the caravan moves on”
It is not for nothing that Dr Manmohan Singh who was Governor RBI in the early 1980’s, called the job of the Governor RBI as the loneliest job in the country.’
In the larger interest of India and the country’s economy, one wishes Dr Rajan survives as the longest serving Governor of the Reserve Bank of India!
*****         *****         *****

 *Submitted version of article published in the July 2015 issue of The Global ANALYST.


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