To let go or not

The only silver lining in the global economy needs an RBI boss capable of innovative solutions to support growth

By Mohan Sule

The battle lines are drawn. On one side are market participants and companies. They feel the Reserve Bank of India has been too miserly in reducing interest rates. The asset quality review ordered by the central bank has compounded the problem. Over the last two quarters, public sector banks have been aggressively making provisions for hopeless loans. The exercise is likely to continue till the end of this fiscal. On the other side are economists and foreign fund managers who feel cleaning up of banks’ balance sheets is a precursor to reducing government’s stake to make the behemoths nimble. Critics want the RBI governor to be more aggressive in cutting the cost of money, while supporters view the cautious approach as enhancing India’s credibility in the financial markets. Unwittingly, both schools seem to converge on the issue of the importance of the monetary authority in steering the economy of the country. Implicit in their disagreement is the consensus that the growth trajectory hinges on the action or inaction of the central bank. The outcome should not surprise those who have witnessed the boom and bust of the global financial markets in the last decade. Pumping of liquidity and wielding of the scissors by the US Federal Reserve, European Central Bank, Bank of Japan and, of late, the People’s Bank of China are keenly watched by global markets to decide their bets on currencies, interest rate and commodity futures. The central banks are no longer mere regulators of the financial markets. They are monitors, correcting the missteps of governments.

No wonder, the market has come to vest in central bank bosses mythical powers. Opinion is consolidating that governors can do no wrong. They are the gatekeepers of the economy, the steady hands on the wheels of ships sailing in turbulent waters. Would the world have slipped into a second global depression if the Fed’s Ben Bernanke had not kept interest rates near bottom and embarked on bond-buying program for more than half-dozen years to boost the US economy? What if Mario Draghi of the ECB had paused injecting liquidity to pull out the euro region from recession? Should the BoJ be credited with saving the economy by keeping interest rates negative to encourage spending? These measures are discussed and debated because they go against the conventional wisdom. Till the 1980s, the International Monetary Fund’s remedy for countries with reckless consumption was to tighten belts by slashing subsidies, devaluing currency and opening up the economy. The austerity measures resulted in social unrest in many countries, undermining the textbook prescription. The 180-degree turnaround in the approach to debt is spurred perhaps by the decade-long depression that cuts in spending resulted in the 1930s. The pump-priming of the economy as a solution to avoid slowdown also shifted the primacy of shaping the economy to the central banks from the government. More than reforms, liquidity is becoming crucial to keep the markets ticking. As such, central banks that prefer to stick to theoretical solutions tend to stand out. To some they are models of rectitude in a feckless market, while to others they are anachronistic dinosaurs that should have extinct during the evolution that followed September 2008.

It does not require great intellect to decipher the position Raghuram Rajan will embrace to tackle economic crises. Initially, the obsession was with inflation due to deficient southwest monsoon. The benchmark was changed from wholesale price index that had dipped into negative due to decline in usage of industrial goods to consumer price index to factor in prices of agricultural output. Corporate India would have faced far more difficult times if global commodity prices too had not declined in tandem due to slowdown in China, allowing pass-through of lower prices. After a gradual and steady reduction in rates, any further cuts were linked to government discipline in spending and borrowing. The budget for the current fiscal demonstrated the government’s resolve to stick to fiscal deficit target by slashing subsidies and preventing leakages. The outflow of foreign portfolio investment has been blunted by the gush of foreign direct investment due to the Make-in-India initiative, thereby avoiding major damage to the currency. Though the rupee is off from the bottom, the weakness has neutralized the benefit of soft crude prices. In the meantime, inflation has started to look up, the fallout of two successive years of scanty rainfall. The answer to the question if a country that is the only beacon of hope in the gloomy global environment should practice traditional economics or break away to chart a unique path to complement growth should determine if R3 should get a second term.