Reserve Bank of India (RBI) Governor Raghuram Rajan tore into his critics on Monday, lobbying for a low interest rate regime to spur economic growth, by stating that such views are “hopelessly optimistic” about the powers of the central bank and any clever solutions in the form of unorthodox painless pathways lead to “depressingly orthodox consequences”.
Rajan was speaking at his first public engagement after expressing on Saturday his desire to go back to academia after his term at the central bank comes to an end on September 3. The outgoing central bank governor, dressed in a sharp black suit and maroon tie, was addressing a packed hall of students and members of academia at the foundation day of the Tata Institute of Fundamental Research (TIFR).
In a long speech that went into lucid explanations of how inflation and interest rate dynamics work in a monetary policy, Rajan, the academician, almost spelt out a point by point rebuttal to arguments charging RBI of misguided actions under his command. Defending his hawkish stance on inflation, Rajan said contrary to perceptions, savings rates have gone up in the economy as the savers are finally getting real interest rates in the form of low inflation. “In recent years, our fight against inflation also meant the policy rate came down only when we thought depositors could expect a reasonable positive real return on their financial savings. This has helped increase household financial savings relative to their savings in real assets, and helped bring down the current account deficit,” he said.
Critics in favour of targeting Wholesale Price Index (WPI) because it is low now would be eager to switch to Consumer Price Index (CPI) when WPI starts rising and crosses CPI, which it has done quite a few times in the past.
In fact, WPI is something that gets influenced by what global policymakers do rather than what RBI does and therefore, it should be CPI that needs to be the policy peg, the governor said.
“By focusing on WPI, we could be deluded into thinking we control inflation, even though it stems largely 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,” Rajan said, adding, “In doing so we neglect Consumer Price Index which is what matters to our common man, and is more the consequence of domestic monetary policy.”
Turning to the charge that RBI killed private investment by keeping rates too high, he said the policy rate in effect plays a balancing act.
Monetary policy is not responsible for high interest rates charged to highly indebted customers, but such companies are charged hefty risk premiums by banks as the lenders presume the loans may not get repaid. “This credit risk premium is largely independent of where the RBI sets its policy rate,” Rajan said.
The central bank also came under fire for the monetary policy failing to show effects on inflation when the economy is supply constrained, especially in case of food inflation. “The reality is that while it is hard for us to control food demand, especially of essential foods, and only the government can influence food supply through effective management, we can control demand for other, more discretionary, items in the consumption basket through tighter monetary policy,” Rajan said. Rajan said the central bank was prepared to face any volatility that may arise due to Brexit. “Brexit can be quite damaging if it happens. Of course, we have factored in some probability of it happening. If it doesn’t happen, you could see some significant rebound. We are preparing for it and monitoring the markets. We have said earlier that we have three lines of defences – good policy, we have pushed out the maturities of foreign borrowings and they are not significantly worrisome at this point, and finally we have plenty of reserves,” Rajan said. “We will do what it takes to moderate market volatility, but once the initial bouts of wave abate, people look for good fundamentals.”
(Source: News Report in Business Standard dated 21.06.2016)
