The Reserve Bank of India (RBI) Governor Duvvuri Subbarao is absolutely right in maintaining that it is “inaccurate, unfair and misleading” to attribute the current economic slowdown to tight monetary policy. The moderation of growth over the past two years is largely a result of bruised investor confidence. This in turn is a product of Government’s policy paralysis, reflected in projects getting mired because of investment bottlenecks, many created by the lack of a coherent approach towards land acquisition and environmental clearances. Subbarao is also not wrong in noting that the RBI’s flexibility in bringing down interest rates was constrained by the Government’s fiscal profligacy, particularly during 2009-12. Given the Government’s lack of any intent to put its fiscal house in order until the latter half of 2012, and wholesale price inflation levels hovering around 9 to 10 per cent for much of 2010 and 2011, the RBI couldn’t have risked embarking on an aggressive rate cutting spree then.

But all this is history. The RBI Governor’s parting shots at the Government, or the present Finance Minister’s not-so-veiled criticism of his predecessor’s inaction, may generate a useful debate about what led to the present crisis. But it will not help in dealing with the problem at hand, which is not inflation as much as a deepening growth and investment slowdown. There can be no clearer confirmation of this than the Central Statistics Office’s data released on Friday, which shows the annual growth in GDP and gross fixed capital formation for the April-June quarter at 4.4 per cent and minus 1.2 per cent respectively. Together with a measly 1.6 per cent growth in real private consumption expenditure, the numbers suggest a drying up of both investment and disposable incomes. Without growth returning, India cannot hope to attract the foreign capital flows necessary to stabilise the rupee and contain the impact of imported inflation.

The situation today demands a coordinated response from the Government and the RBI, one that identifies growth as the dominant concern. The Government’s focus should be on fiscal consolidation, with emphasis on redirecting the savings from compressed subsidies and other wasteful consumption spending towards public investment in infrastructure projects that have the maximum ‘multiplier effect’. This should be complemented by aggressive repo rate cuts and lower cash reserve requirements for banks from the RBI’s side. If nothing else, it will reduce the interest outgo for cash-strapped firms and spur construction activity because of cheaper home loans. Subbarao will be remembered as a Governor who resisted the Government’s attempts at dictating monetary policy and undermining the RBI’s autonomy. He has made the point and is going out without losing the battle. One hopes Subbarao’s successor is able to adopt a more accommodative monetary stance on the clear understanding that the Government will keep its side of the bargain.

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