Game, Set and Match To…?

The ball is now firmly in the cen­tral bank’s court. It is for Raghu­ram Ra­jan to re­spond suit­ably

The Economic Times - - The Edit Page - Mythili Bhus­nur­math

Had this been a ten­nis match, one could prob­a­bly have cheered and said ‘Bravo’. Con­sider this. The RBI lobs the ball to the gov­ern­ment, says it can act only if the lat­ter sticks to the fis­cal roadmap. The gov­ern­ment lobs it back, ad­heres to the 2015-16 tar­get and sticks to the 2016-17 tar­get. It then goes one fur­ther: re­duces in­ter­est rates on small sav­ings and fol­lows it up with some fairly hard-nosed re­forms.

Game, set and match to the gov­ern­ment for suc­cess­fully — and re­peat­edly — lob­bing the ball to the RBI? Not quite.

For one, this is not a ten­nis match. For an­other, what is at stake is eco­nomic growth, the fu­ture of millions of youth des­per­ate for jobs that only strong eco­nomic growth can de­liver.

FM Ticks All the Boxes

From the RBI’s per­spec­tive, it was per­haps not meant to be like this. When gover­nor Raghu­ram Ra­jan lobbed the ball to the gov­ern­ment in Fe­bru­ary 2016, say­ing “struc­tural re­forms in the forth­com­ing Union Bud­get that boost growth while con­trol­ling spend­ing will cre­ate more space for mone­tary pol­icy to sup­port growth”, the un­spo­ken state­ment seemed to be that the RBI had done its bit. It was for the gov­ern­ment to re­spond.

Well, the gov­ern­ment has re­sponded. With the finance min­is­ter stick­ing to the fis­cal tar­get, the US Fed­eral Re­serve stay­ing put on in­ter­est rates and turn­ing de­cid­edly dovish for now, and in­ter­est rates on small sav­ings com­ing down sharply, the pres­sure on the RBI to re­spond ap­pro­pri­ately has in­creased tremen­dously. Es­pe­cially since macroe­co­nomic fun­da­men­tals re­main iffy even as in­fla­tion num­bers seem within reach of the RBI’s tar­get of 5% for March 2017.

So, the ques­tion is not so much whether the RBI will cut the repo rate to­mor­row as whether it will con­tent it­self with a 25-ba­sis-point re­duc­tion. Or go in for more ag­gres­sive mone­tary eas­ing. The op­tions range from a 50-ba­sis-point cut in repo rate to a cut in cash re­serve ra­tio to a new, more re­al­is­tic liq­uid­ity frame­work.

As Ra­jan weighs the op­tions, the clincher, as al­ways, is the growth-in­fla­tion trade-off. Whole­sale price in­fla­tion has been in neg­a­tive ter­ri­tory for — hold your breath — 16 months. Con­sumer in­fla­tion was well be­low the RBI’s tar­get for Jan­uary 2016.

So, has the RBI been hoisted by its own petard? In mone­tary (as in fis­cal) pol­icy, tim­ing is crit­i­cal. Today, with the ben­e­fit of hind­sight, it is hard to shake off the nag­ging sus­pi­cion that ex­ces­sive fo­cus on beat­ing down in­fla­tion blind-sided the RBI.

It ig­nored the flip side of, first, cutting rates be­lat­edly, and then keep­ing liq­uid­ity tight, crimp­ing an al­ready leaky trans­mis­sion mech­a­nism that im­peded full pass-through of mone­tary sig­nals. This, com­bined with its in­sis­tence that banks clean up their bal­ance sheets in a rel­a­tively short time span, de­spite an eco­nomic down­turn, turned banks risk-averse. This led to the un­in­tended ef­fect of killing a nascent re­cov­ery.

Can the RBI make up for be­ing be­hind the curve (read: fail­ing to cut rates more sharply ear­lier) by cutting more ag­gres­sively now? Will a larger-than-ex­pected rate cut spur grow- th? Could it spur in­fla­tion? That is the RBI’s dilemma. There is no know­ing for sure.

Given the cur­rent growth-in­fla­tion dy­nam­ics, chances are it will be pos­i­tive for growth and do less dam­age to in­fla­tion. But that could well change, as Ra­jan knows all too well. It is a risk, but one worth tak­ing. Even if means he has to ig­nore his in­stincts and give growth a chance.

Guv, Go for Gains

Time is run­ning out. The Fed will raise rates this year, even if at a slower pace. Com­mod­ity prices, soft for now and likely to re­main so for a while, could re­verse. Early in­di­ca­tions are that the mon­soon, which could play spoil­sport and push up food in­fla­tion, is likely to be nor­mal. So the RBI has a small win­dow of op­por­tu­nity.

More­over, as things stand, Ra­jan has only two more bi­monthly poli­cies to go be­fore his term ends on Septem­ber 4. What’re the odds that the gover­nor will re­turn the finance min­is­ter’s care­fully placed shot with a stronger-than-an­tic­i­pated back­hand? It’s hard to say. Re­mem­ber, this is a gover­nor who, in his very first pub­lic state­ment on Septem­ber 4, 2013, took care not to rule out sur­prises. “A cen­tral bank should never say ‘Never’.”

Re­mem­ber also, that many of the five pil­lars Ra­jan out­lined in Oc­to­ber 2013 re­main works-in-progress. The mone­tary pol­icy frame­work has been strength­ened. But this is yet to re­ceive leg­isla­tive sanc­tion. More play­ers have got banks li­cences. But li­cences are still not on tap.

Fi­nan­cial mar­kets have been deep­ened. But this is, nec­es­sar­ily, an on­go­ing process. Fi­nan­cial in­clu­sion has im­proved, thanks to Jan Dhan. But mi­cro, small and medium en­ter­prises (MSMEs) re­main ex­cluded. As for the fifth pil­lar — strength­en­ing banks’ hands against re­cal­ci­trant bor­row­ers — we still have a long way to go. We may even have paid an un­in­tended, but heavy, price.

Given this mixed record, will Ra­jan go against con­ven­tional wis­dom and give it all he has, risk­ing his record on in­fla­tion? Or play safe with a 25-ba­sis-point cut in repo rate? Given the gover­nor’s in­nate con­ser­vatism, chances are he will pre­fer the lat­ter. The loser, once again, could be the nascent eco­nomic re­cov­ery.

Strum­ming up some courage

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