If statements of various functionaries of the Union ministry of finance and the Reserve Bank of India (RBI) are anything to go by, India seems to be caught in a trade-off between maintaining reasonable growth and facing higher inflation. It is a mix of an old textbook story and a conflict of mandates between the ministry and RBI.
The ministry is concerned about a disruption in growth if RBI increases policy rates and the cash reserve ratio. Any policymaker would be. But there is also an unsaid concern behind this stand: If growth is hit, government revenues too will be affected. In that event, plugging the country’s fiscal deficit—the highest in recent years—will become very difficult, if not impossible. Macroeconomic management may get complicated in the coming years.
Illustration: Jayachandran / Mint
RBI is concerned about price stability and inflationary expectations. With inflation of food items touching 18.22% in mid-December, there are concerns that inflation will spill into manufacturing. In October, RBI governor D. Subbarao had said its inflation expectations survey indicated that a majority of respondents expected the inflation rate to increase over the next three-four months and also the next year. Various RBI officials have reiterated these concerns and hinted at monetary tightening.
The concerns of both the ministry and RBI are well founded. Under normal conditions, it would be easy to make a call and take appropriate measures. But these are not ordinary times. India has barely managed to escape the global recession and there was a growth scare in the first two quarters of the current fiscal. What eased the situation was the huge monetary and fiscal loosening. While that effort has worked, it has created policy difficulties. On the one hand, continuous cutting of interest rates since 2008 has helped the revival, it could not be expected to help overcome bottlenecks in agriculture. On the other hand, fiscal loosening has ensured hardening of prices in that area. This now threatens general inflation. But if interest rates are increased, they can hit other sectors. The way out is not clear-cut.
Here it is apt to point out that repeated statements by government officials that there is no need for monetary tightening or that inflation will ease in the next few months (how and why?) do not help. RBI, like the central bank of any well-run country, is independent. There are internal mechanisms (such as the high-level coordination committee) to iron out differences and it makes no sense to air divergent opinions in public. That smacks of ham-handed efforts at putting pressure on RBI.
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