Last week’s decision of the Reserve Bank of India (RBI) to raise its policy rate by 50 basis points took centre stage as much due to the surprise factor (market analysts were completely blindsided) as it did with the import (the threat of double-digit inflation is for real) of the decision. While these reactions are spot on, they ignore the subtext: it is yet another example of someone stepping forward to breach the governance deficit, just like the Supreme Court and civil society took the lead in tackling corruption.
May sound odd. Absolutely. But, hear me out.
Governance is not just about ensuring law and order. As we now know, it means that the government protects citizens against corruption, especially in public office. More importantly, especially when inflation is dangerously close to double-digit territory, it also means protecting them against the vagaries of inflation—it erodes purchasing power, which worsens as you go down the family income ladder.
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In this, RBI has an important, yet limited role—when compared with that of the Union government—in battling inflation. It does this through its monetary policy, as in the latest instance, by raising the cost of money. It hopes this will curb demand in the economy and thereby dampen inflation.
On the other hand, the Union government has several means at its disposal to curb inflation. The most important measure, of course, is to curb the fiscal deficit, or its gross borrowings—one of the single biggest components of demand in the economy.
It was at the root of the unprecedented economic crisis that beset the economy in 1990-91. (Ironically, India is, as a former finance minister pointed out, almost back to square one: a situation of high inflation, high interest rates and low growth.) After a sustained battle, substantial inroads were created which eventually led to some containment of annual accretions to government debt. However, in the last few years, particularly because of the huge fiscal stimulus provided immediately after the global meltdown in 2008, the fiscal deficit pressures have returned.
The Union budget for 2011-12 chose to be an optimist and consequently ignored the incoming tide. The latest official fiscal data shows how misplaced this assumption was. At the end of the first quarter of the current fiscal, it was Rs1.62 trillion, compared with Rs40,196 crore in the same period last year.
RBI has been signalling, for some time now, that the ball is in the finance ministry’s court; somehow North Block has not gone beyond making the right noises. Accepting that there is nothing that can be done immediately to curb the fiscal overrun, RBI decided to be savage with its hikes—the 11th since March 2010. This is the political economy of RBI’s action: it has taken upon itself to do whatever it can, even if it means compressing growth, to fight the single biggest macroeconomic threat—inflation.
Ideally, it should have been working in tandem with the Union government, which has been struggling to get out of the firefighting mode and focus on policy manoeuvres. But, now in the not-so-ideal circumstances, it has decided to act alone.
There are enough pointers in RBI’s policy note confirming this; the trick as always is to read the subtext. One of the four risks detailed by RBI for the projections on growth and inflation for 2011-12 is the fiscal deficit (it also devotes maximum text to this issue, though it is listed as the fourth risk).
It begins by saying “subsequent developments” have made the task of achieving the fiscal deficit target of 4.6% of gross domestic product “more of a challenge”. The niceties end right there. The next sentence sums up RBI’s certitude on the Union government’s inability to curb fiscal overrun.
“On the expenditure side, the subsidy burden will, in all likelihood, overshoot the budgeted amount in 2011-12 significantly, despite the recent revision in petroleum product prices,” the policy statement said.
Going on to detail pressures on the centre’s revenue receipts, it sums up its prognosis: “The large fiscal deficit has been a key source of demand pressures.” And then concludes very contritely: “Fiscal consolidation is, therefore, critical to managing inflation.” QED, as mathematicians would say.
There is, however, an even larger lesson to be drawn from such a governance-deficit failure. Increasingly non-state actors, such as civil society, are gaining ground and forcing the initiative. So far the efforts have largely been in the right direction. There is, however, unlike in the case of RBI, no guarantee this will endure. Just as civil society action can be hijacked by unsavoury elements, the recent acts of overreach of the judiciary suggest that there is no replacement for appropriate executive action—in a democracy you can question executive action, but you can replace it only at the risk of anarchy.
The United Progressive Alliance (UPA) is a democratically elected government, which has seemingly lost its way in the first two years of its second term in office. There may be, as some Union ministers have recently signalled in their media interactions, a turnaround in the offing. If not for their own political survival, at least for the sake of the country, one hopes they are right. We deserve better.
Anil Padmanabhan is a deputy managing editor of Mint and writes every week on the intersection of politics and economics. Comments are welcome at email@example.com