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Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan on Monday argued the case for continuing the fight against inflation, saying that it would be wrong to change course even though the period of adjustment from high inflation to low inflation can be painful.

Rajan, who on Saturday said he would not seek a second term as RBI governor when his tenure ends in September, said India had benefited tremendously from its focus on inflation and the attempt to put an institutional framework focused on inflation in place.

Under Rajan, RBI has moved to targeting a level of consumer price inflation and intends to bring inflation down to 4% (+/-2%) over the medium term. The government is also in the process of setting up a monetary policy committee (MPC), which would henceforth have the responsibility of setting monetary policy for the economy.

As he demits office, Rajan said these reforms should be taken to their logical conclusion.

“In the days ahead, a new governor, as well as the members of the committee will be picked. I am sure they will internalize the frameworks and institutions that have been set up, and should produce a low-inflation future for India," Rajan, whose decision to resign came as a surprise to the markets, said in a lecture he delivered in Mumbai.

Rajan noted that one of the reasons the Indian rupee has been stable is because investors have gained confidence in the country’s monetary policy goals. This confidence will improve as the country meets its inflation targets, said Rajan, while arguing that the rewards of stable and low inflation “are many".

“Foreign capital inflows will be more reliable and increase in the longer maturity buckets, including in rupee investments. This will expand the pool of capital available for our banks and corporations. The government will be able to borrow at low rates, and will be able to extend the maturity of its debt. The poor will not suffer disproportionately due to bouts of sharp inflation, and the middle-class will not see savings eroded. All this awaits us as we stay the course," Rajan said.

Rajan noted that fighting inflation is never easy and results in a push-back by those who benefited from negative real interest rates as a consequence of high inflation. All constituencies must make adjustments if the country is to benefit from a sustained fall in inflation.

“For example, if industrialists want significantly lower rates, they have to support efforts to improve loan recovery so that banks and bond markets feel comfortable with low credit spreads. The central and state governments have to continue on the path of fiscal consolidation so that they borrow less and thus spend less on interest payments. Households will have to adjust to lower nominal rates, but must recognize that higher real rates make their savings more productive," he said.

Rajan has often been criticized for not bringing down rates quicker, though the central bank has cut its benchmark repo rate by 150 basis points since the start of 2015. One basis point is one-hundredth of a percentage point.

At its last policy review on 7 June, RBI kept rates steady, citing the resurgence of inflation pressures.

Consumer price inflation quickened to 5.7% in May, well above RBI’s target of bringing down inflation to 5% by March 2017.

“Adjustment is difficult and painful in the short run. We must not get diverted as we build the institutions necessary to secure a low inflation future, especially because we seem to be making headway," said Rajan.

He termed the government’s decision to put in place a Consumer Price Index-based inflation objective for RBI as well as a framework for setting up an independent monetary policy committee as “momentous".

He also said the recent spike in inflation vindicates the central bank’s past decisions to ignore calls for deeper rate cuts.

Taking on some of the criticisms RBI has faced on targeting retail inflation instead of Wholesale Price Index (WPI) inflation, Rajan said such criticism was misplaced.

Explaining that wholesale inflation does not reflect the whole gamut of prices that affect the common man, Rajan said focusing on low wholesale price inflation could delude the central bank. “Now that we have appropriate CPI inflation, there is no excuse to go back to WPI," he said.

Rajan reiterated there is no long-run trade-off between growth and inflation. The best way for a central bank to ensure sustainable growth is to keep demand close to supply so that inflation remains moderate, and the other factors that drive growth, such as good governance, can take centre stage.

“We can never abandon (the fight against) inflation to focus on growth," he said.

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