Imagine the following scenario: The central bank has been trying valiantly to control inflation. It is using every trick in its books to tame the monster. Apart from frequent interest rate hikes, it makes hawkish sounds, curtails credit, and also urges the central government to cut wasteful spending, and rein in the fiscal deficit.
It wants to safeguard its integrity and autonomy, especially from the government. It says that in the conduct of prudent monetary policy, undue pressure from the government or the industry is unhealthy and unwelcome.
Critics and inflation hawks say that the central bank should be more bold, nay audacious. But the central bank is losing the inflation battle, thanks largely to fiscal undoing. So, what else is the governor supposed to do? Resign in protest?
That’s exactly what happened in neighbouring Pakistan. The central bank governor Shahid Kardar resigned this week, saying that the bank was being impeded from discharging its mandate. The days of hyphenating with our notorious neighbour are long gone, but the similarity of the predicament of our central banks is inescapable.
The Reserve Bank of India (RBI) is under pressure not just from industry and the bankers’ lobby, but also from the government to pause its rate hikes, as if RBI alone is to be blamed for the visible industrial slowdown. Despite 10 rate hikes so far, the headline inflation is stuck close to double digits, and will go up further in the coming months. The onslaught of global liquidity is not helping either. Inflation is broad-based, no longer confined to food, or attributable only to international commodity prices. Rising core inflation suggests demand pressure, which must be subdued in the short run.
A growth moderation of about 1 percentage point would be a small price to pay if it gets inflation quickly below the artificial and unacceptable “new normal” of 7%. Else wage and price expectations will chase each other into an upward spiral, making it even harder to “unspiral” back later. RBI’s own surveys are pointing to a spiral in the making. India’s headline inflation is among the top three in the emerging markets globally.
Hence, real rates are near zero or negative, and these alone certainly don’t dampen investment enthusiasm. In fact, borrowers should be drooling, since inflation will eat away some of their cost of borrowing.
It is true that investment spending has slowed, but that is not because of hardening interest rates alone. Sagas of scams have played a role, export optimism is dented by nervousness in euro zone and weak US data, and slowing consumer finance is affecting real estate and automobiles. But credit is still rising at 20% and consumer spending growth is still respectable. If, however, high inflation persists, as RBI has warned, it will hurt growth much more in the longer run.
This is the wrong time to slacken policy stance, since such a signal damages credibility of RBI’s commitment to low inflation. In any case, the inflation battle cannot be won without close coordination and alignment of fiscal and monetary policy. The fiscal authorities are showing no signs of restraint, so RBI’s hawkish determination needs to redouble.
The International Monetary Fund too has advised in its recent World Economic Outlook, that policy tightening ought to continue. It also calls for rebuilding fiscal room. Our fiscal spenders need to wake up, but thankfully unlike Pakistan, the RBI governor doesn’t need to contemplate resignation to make his point.
Ajit Ranade is chief economist, Aditya Birla Group. These are his personal views.
On 26 July the Reserve Bank of India will announce its quarterly review of monetary policy. Will it continue to tighten the policy with yet another rate hike to fight high inflation or will it press the pause button as growth is being threatened? This is third of a series that Mint will carry over this week in the run-up to the policy