In his first public appearance since announcing he will not seek a second term as RBI Governor, Raghuram Rajan on Monday gave a point-by-point rebuttal to his critics, while highlighting the need to continue the fight against inflation and the need to stay the course on policy rates.
Defending the central bank’s actions, Rajan, while delivering a lecture at the Tata Institute of Fundamental Research, addressed those who have accused him of keeping interest rates too high, saying they cannot “have it both ways, want lower inflation as well as lower policy rates”.
“The fact that inflation is fairly close to the upper bound of our target zone today suggests we have not been overly hawkish, and were wise to disregard advice to cut more deeply,” he said.
On the issue of consumer price index (CPI) versus wholesale price index (WPI) inflation, Rajan said that since monetary policy “works” by containing the public’s inflation expectations and thus wage demands, CPI is what matters.
“A low WPI could result from low international inflation, while domestic components…such as education and healthcare services and retail margins and non-traded food, are inflating merrily to push up CPI. By focussing on WPI, we could be deluded into thinking we control inflation, though it stems from actions of central banks elsewhere.
“In doing so, we neglect CPI, which is what matters to our common man, and is more the consequence of domestic monetary policy,” he said.
Rajan observed that one reason critics may advocate a focus on WPI is because it is low today, and thus would mean low policy rates. This is short-sighted, for when global inflation picks up, WPI could well exceed CPI.
It is erroneous, he added, to attribute all components of the interest rate paid by the borrower to monetary policy.
Rajan felt that it would be far more useful to improve lending institutions and borrower behaviour to bring down the credit risk premium than to try and push the RBI to lower rates unduly.
The bottomline, he said, is that in controlling inflation, monetary policy makers end up balancing the interests of investors and savers over the business cycle.
Rajan said that some argue, rightly, that it is hard for the RBI to directly control food demand through monetary policy. They then proceed, incorrectly, to say the RBI should not bother about controlling CPI inflation.