A HAPPY ARRANGEMENT

The RBI sprang a surprise on the markets when unannounced, it pared off another twenty-five basis points from the bank rate a mere four days after the Budget. Whether it was done to adhere to the new parameters set in the Budget for the monetary policy is not known. But this much is clear. Consumer inflation is well within the two to six percentage target, which the central bank was given to follow while framing its monetary policy. Raghuram Rajan, the well-regarded RBI Governor, had earlier also reduced the basic rate by the same 25 basis points without waiting for the scheduled monetary policy review. Even the latest cut came as a surprise, since the markets were least expecting it. Still, the reaction of the markets was not all that euphoric as you would have expected. Maybe the somewhat muted response of the bellwether Sensex was due to the fact that it had already factored in the cut, following the sharp decline in the wholesale and consumer price inflation. Yet, the fact that there will now be some predictability in the bank rate due to the clear guidelines set for the central bank ought to make for greater clarity in the equity markets. Besides, the tension between the Mint Street and North Block, which houses the offices of the finance ministry, is bound to lessen, following the setting up of a monetary committee. The Committee, most likely to be chaired by the RBI Governor, ought to be always chaired by the RBI Governor, though it will have representatives of the ministry, as well as a few independent experts. This will make for smooth relations between the central bank and the finance ministry. Considering how Finance Minister P Chidambaram used to pressurise the RBI Governor for rate cuts, the formation of a monetary committee, and clear guidelines on inflation trajectory between two to six per cent over three quarters, will make for an orderly management of the monetary policy. Yet, it must be noted that despite the best efforts and intentions of the central bank, it may not always be possible for it to manage inflation and keep it within the pre-chalked out bands. For quite aside from the monetary policy, many other factors go to determine the inflation rates at a given time. For instance, the sharp downturn in the global crude prices has had a salutary effect on the inflationary pressures in the economy, despite everything else remaining virtually unchanged. Again, a lot will depend on how the fiscal policy is in consonance with its inflation management targets. A reckless fisc could make it hard for the RBI to contain inflationary pressures. Also, given the farm sector’s reliance on the monsoons, agriculture production in a bad year could result in higher food prices. Again, there could be a mismatch between demand and supply in the food market.

The point being that the inflation parameters given to the proposed monetary committee should serve as a guide, and not as binding targets to be adhered to under all circumstances. Which is just as well. Failure to stick to the targets for three consecutive quarters will require the RBI to furnish grounds for such a failure. In other words, it is a smooth arrangement that the central bank and the finance ministry have agreed upon after due deliberation. Contrary to the initial reports, the RBI has reason to be happy at the new arrangement, since it relieves it of the burden of daily pinpricks from the political establishment, which, without really knowing its mind, often lends its ear to vested interests who demand drastic cuts in the prime lending rate. Now, even the captains of industry and commerce will know whether or not a cut in the bank rate is warranted.