Confusing economic signals from governments are capable of causing mayhem in the markets even at the best of times. When there is high uncertainty, this only creates more problems. This is avoidable. Yet, in the span of the past one week, finance minister Pranab Mukherjee and chief economic adviser Kaushik Basu have sent contradictory signals on monetary policy. This is something for the Reserve Bank of India (RBI) to decide and comments by ministers, and officials give rise to confusion.
On Friday, in Busan, South Korea, Mukherjee said India would continue consolidating its fiscal position and would not pause in increasing interest rates. He said this against the backdrop of a European debt crisis. Several European economies such as Greece, Spain, Ireland and now Hungary are in trouble because of high debt levels. These have rattled bond markets in Europe and the fear is that “economic contagion” may hit other, more sound, economies. This could lead to what is called a “double-dip” plunge in the global economy. Global economic recovery continues to be fragile and has barely managed to stay afloat after the subprime crisis. If another crisis were to emerge, it certainly will affect India adversely.
Despite this uncertainty, Mukherjee chose to say what he did. His statement could be rationalized in view of the high inflation in India and the persistence of inflationary expectations, even as the economy powers ahead with an expected 7-8% annual growth rate.
Yet, curiously, within the next 24 hours, he advised these countries not to go in for a coordinated exit as such a step could stop economic recovery. Then, the next day, on 6 June, Basu said in an interview that RBI should not effect an increase in the cash reserve ratio (CRR). An increase in the CRR means that banks have to set aside more money as reserves. This means less money for lending and, in turn, less liquidity in the system. Basu also said inflationary fears were overplayed and that food inflation was the result of a base effect.
These statements only confuse the markets, especially the bond market, which is particularly sensitive to government statements about monetary and fiscal policies. At a time of strong economic growth, availability of money for investment and capacity expansion is important for checking inflation. Unfortunately, mixed policy signals add uncertainty to this process. If only for the sake of continued growth and inflation management, our policymakers should be more careful about what they say.
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