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Having won the battle (but not the war) against currency volatility, RBI governor Raghuram Rajan had two more targets in front of him-rising inflation and slowing growth. In the recently announced policy, he has chosen to train his guns at rising inflation.
Rajan has continued fine tuning the economy by increasing the repo rate by 25 basis points and at the same time cutting the Marginal Standing Facility (MSF)
by a similar amount. In musical terms, his actions are akin to
increasing the volume (treble) and reduce the
bass. Net result- you get
to hear the voice without being overpowered by the surrounding music.
And the governor’s voice that comes out clearly says that he would fight
inflation no matter the cost (to growth).
Rajan seems to have conceded his fight for increasing growth rate.
This has been left to the government who will have to bring in the right
kind of policies and confidence building measures that can incentivise
investments. Rajan however has mentioned that he hopes that growth will
pick up on account of revival of large projects and the clearance of
pipeline by the Cabinet Committee on Investment (CCI). However, neither
PMI data nor non-food credit flow betrays a pick-up in activity.
That brings us to the current battle between the governor and
inflation. By increasing repo rate, Rajan is trying to strangulate
inflation and hope to squeeze the life out of demand, especially during
festive season. This however, does not match the finance ministry’s step
of allowing subisidised money to consumers during the festive season.
Thankfully, finance ministry’s measures are restricted to PSU banks
while RBI’s measures will be applicable to all banks.
In any case, persistent and sticky inflation is a result of supply side
problem rather than demand. So is the governor shooting at the wrong
target? Not quite.By trying to curb demand, he is allowing supply side
to catch up with the reduced demand. But that’s like shooting a tank
with a pea shooter. External environment does not support suppliers to
increase their capacities. Unless this is handled, inflation, both food
and non-food are likely to remain high.
Though RBI governor might put up a brave face and attempt to control
inflation, there is very little he can do. By increasing repo rates, he
has punctured one more hole in the wheels of growth. It is only through
growth that he can hope to win not only the battle but war against
inflation. At best,he is hoping to arrest inflation at the current
level, and hoping that reinforcement in the form of growth will come and
rescue him.
But the second quarter policy has nothing in it to help revive growth.
Rajan is following his predecessor, D Subbarao’s footsteps in fighting
inflation and sacrificing growth. We very well know where this policy
landed us. For that, we will have to wait for his development policies
to be unveiled. Till then we will continue to move with the governor’s
foot on the brake pedal.
