New Delhi: For months, India’s hawkish, inflation-fighting central bank has been in a shrinking minority of its emerging market peers. Now the recently re-appointed central bank governor is facing stiff opposition to his crusade at home.
As recently as last week, the Reserve Bank of India made clear it will stick to its anti-inflationary stance despite censure from the Congress-led government that is signaling 12 rate rises within 18 months are hurting growth and its electoral prospects.
India’s inflation is near 10%, one of the highest among major economies in the world.
It is among a handful of countries such as Kenya and Nigeria still raising rates while the world frets over headwinds from a European debt crisis and a sputtering US economy. Neighbours in Asia have turned dovish, some such as Brazil and Turkey have already cut interest rates.
Subbarao appears undeterred by the criticism. Central bank sources say he is determined to keep policy tight, maybe even tighten it further.
“Growth has a floor, but inflation has no ceiling,” said a senior RBI official with direct knowledge of monetary policy making. “If we don’t do anything, inflation expectations will rise.”
Until now, the government and the Reserve Bank of India have largely been on the same page when it comes to monetary policy, with near double digit inflation not only an economic worry but a political headache as prices of foods and fuel jump.
But over the past few weeks, criticism and advice for the RBI chief have been more blunt than usual.
“I have had hesitation on a rate hike this time which in the past I did not”, Kaushik Basu, chief economic advisor to the finance ministry, said after the RBI raised the repo rate by 25 basis points on Friday.
“I would personally, yes, vote for pause”, he told reporters when asked what the RBI should do at its October policy review.
Basu is a top adviser in the finance ministry and is known to be not only close to finance minister Pranab Mukherjee but also a key strategist on economic policy, one who often echoes Mukherjee’s thinking on key issues.
The top adviser, who is a trained economist and was widely believed to be in the race for the RBI top job, has asked the central bank “to think out of the box” and consider the examples of Brazil and Turkey that cut rates to protect growth.
Montek Singh Ahluwalia, the deputy chairman of Planning Commission and Prime Minister Manmohan Singh’s close advisor, also questioned Subbarao’s monetary actions.
“You need to ask yourself whether interest rate is the best instrument to bring inflation under control. Are there other instruments?”, Montek told Reuters in an interview on Friday.
Finance Minister Pranab Mukherjee had hinted early this month that the central bank should stop tightening monetary policy, an indication that the government was worried about the impact of high interest rates on growth.
The government fears it may have a political cost to pay when the largest Uttar Pradesh goes to the polls next summer, widely billed as the semi-final before the 2014 general elections.
In recent days voices outside government have also grown shriller against high interest rates.
Indian industry is worried about margin pressures while the anger of the vast Indian middle class, already at a high because of a price hike in petrol and high food prices, is now boiling over as home buyers and borrowers shell out higher installments.
Some support for Subbarao
Governor Subbarao is guided by other factors. RBI-watchers say he would not like to leave behind a legacy of unhinged inflation, even if it means risking the displeasure of his political bosses and sacrificing some short term growth.
“Between a below 8% growth and 9% inflation, we choose to contain inflation. That is the net decision”, said another senior RBI official who declined to be named.
Another reason Subbarao would continue raising rates in October is the weak rupee, which is at 2-year lows, setting him back in his fight against inflation. He would hope a rise in interest rates would get overseas capital flowing back to India even if right now it is flowing out to safe havens.
There are some in his fraternity who understand his dilemma and are willing to back him. C. Rangarajan, a former governor of the RBI and a close adviser to Prime Minister Manmohan Singh, is one such person.
“The RBI governor is right, as any monetary authority, to be concerned about inflation and his priority is fighting it. Rightly so, because inflation is high”, Rangarajan said.
Subbarao who was criticised for being behind the curve in fighting inflation, enjoys the confidence of Prime Minister Manmohan Singh, an economist and former chief of the RBI.
The governor’s second term in office was approved by an appointments committee led by the Prime Minister.
Little help from the government
Ironically, it’s Singh’s government which has encumbered the RBI by initiating what analysts reckon are fiscally imprudent entitlement schemes such as the rural jobs programme.
Progress in pushing through key reforms, such as ushering in foreign direct investment in the retail sector, has been painfully slow. A decision to relax norms for overseas debt has meant fiscal policy runs counter to the RBI’s tight money policy.
Government officials have not helped the governor’s cause. By frequently talking out of turn with their own projections on inflation, they have muddied the waters on expectations to the point of almost undercutting the central bank’s authority.
Governor Duvvuri Subbarao was handpicked by former finance minister P. Chidambaram to head monetary authority to ensure fiscal and monetary policies moved in tandem in the aftermath of the global financial crisis of 2008. That worked.
Like Subbarao’s predecessor Yaga Venugopal Reddy, the current governor and his team have increasingly made it clear that Subbarao is his own man when it comes to taking tough monetary decisions.
“We are a poor country and for social reasons we can’t let inflation expectations rise,” said a senior official in the RBI who declined to be identified by name.
“We have already accounted for short-term sacrifice in growth for a durable medium to long term growth.”
Subir Gokarn, a deputy governor at the central bank, indicated in an interview to Reuters that the peak of the rate hike cycle is in sight though India could face near double digit inflation from September to November.
Reddy fended off political pressure from the government in the first Congress-led government of 2004 to 2009 to keep rates low. Reddy made it clear inflation strategy would override any political concerns.
Subbarao is in fact using the only weapon that he has in his armour: interest rates.
“I think the RBI has done the right thing so far by raising rates because in my opinion it’s more demand pull than cost push inflation right now.” said N. R. Bhanumurthy, senior economist with National Institute of Public Finance and Policy, a Delhi based economic think-tank.
“So interest rates are one way to curb demand.”