The Reserve Bank of India (RBI) released its mid-quarter monetary policy Review on September 16, 2011. Predictably, the RBI raised the repo rate from 8.0 per cent to 8.25 per cent, the reverse repo rate from 7.0 per cent to 7.25 per cent and the marginal standing facility from 9.0 per cent to 9.25 per cent.
These baby steps should not have caused any furore. But the uproar was on account of global problems, and a fall in output together with persistently high inflation in India.
INFLATION THREAT
The global situation has gone from bad to worse and the US, Europe and Japan are hurtling into an abyss. The Emerging Market Economies (EMEs), having been accommodated on the High Table of the Big Boys, will be expected to give a helping hand to the industrial countries.
In India, real growth is showing signs of some slowdown from the heady 9 per cent levels and the cherished aspirations of a 10 per cent growth rate are dashed. It is conceded in official circles that India would find it difficult to attain a 9 per cent annual rate of growth during the 12th Plan.
Despite the efforts of the RBI, the inflation rate is close to the psychologically dreaded level of 10 per cent. It bears mentioning that the official price indices, the world over, generally understate the actual rate of inflation. Even if the rate of inflation comes down, the level of inflation would be higher and thereby put a cruel burden on the weaker sections of society.
Given the international and domestic developments, it is imperative that India quickly crushes inflation. Increases in policy rates by 0.25 per cent should surely not be considered as harsh measures. Even the cumulative increase since March 2010 of a little over 3 percentage points should not be considered as drastic, given that after the global financial meltdown Indian interest rates were very low. The repo rate of 8.25 per cent is still a negative real rate and, therefore, the monetary tightening can hardly be called harsh.
It is reported that India Inc. is angry with the RBI. Further, critics of RBI argue that if a series of interest rate increases have not been able to bring down inflation, any further interest rate increases would be counter-productive.
NEEDLESS CRITICISM
The other arms of economic policy have just not delivered and the only wing of policy that has been proactive is monetary policy; it is grossly unfair to blame RBI for the slowdown of the economy along with continued high inflation. The criticism of the RBI, if at all, should be that it has not operated fast enough and sternly enough—but that is nobody's case.
The window of opportunity is very narrow and baby steps taken over a prolonged period create more tensions than sharper policy steps. The late Dr I. G. Patel, when he was the Governor, would often stress that one-shot measures create less policy tensions than a series of small steps. The government has an overbearing role in the formulation of monetary policy. Hence, it is not fair or appropriate for the government to distance itself from the latest monetary policy.
Sound bytes emanating from the government seemed to imply that monetary policy was the last hope for dealing with inflation, which incidentally is generalised and much as government policymakers wish to deny it, generalised inflation is a monetary phenomenon.
There is an unwritten code of conduct that the government does not criticise the RBI in the open as it is a party to the decisions. The Chief Economic Adviser, the renowned Dr Kaushik Basu, in an unprecedented outburst on the eve of the policy, is reported to have said that monetary tightening had harmed growth instead of taming inflation, which was a public message to RBI to desist from raising interest rates as higher interest rates would attract more foreign capital and thereby fuel inflation.
The ground realities are that, on the contrary, there have been capital outflows. Again, the Finance Minister expressed the hope that the existing policy to control inflation would not be extended.
As Ms Kalpana Kochhar, Chief Economist, Asia Region of the World Bank, rightly pointed out, the reference to Turkey as a model to follow was not appropriate as Turkey had received massive capital inflows; in contrast, in the case of India there have been capital outflows.
Policymakers of today should read the Parliamentary records of the early part of 1982, when the then Finance Minister, Mr, Pranab Mukherjee, in a Calling Attention Motion on the RBI Monetary Policy provided a magnificent defence of the RBI. This should be a mandatory read for all policymakers.
The formulation of the September 16, 2011, monetary policy of the RBI must have been a period of great anxiety for the top management of the RBI. Kudos to the RBI for holding on to its faith.
Dr Manmohan Singh, as Governor, in the early 1980s, would say that the Governor of RBI was performing loneliest job in the country. As the French philosopher Voltaire said, it is dangerous to be right when the government is wrong.
(The author is an economist. >blfeedback@thehindu.co.in )