Borrowing the illustrious words of Nobel prize-winning economist, Paul Krugman, the governor is convinced of the good effects of following “hard money orthodoxy”. RBI’s policy under Subbarao is orthodoxy indeed! It does not take into account any of the ground level realities even; it does not much recognise that food inflation is not proving to be much responsive to interest rate; and, it disbelieves all government promises to bring down fiscal deficit to reasonable levels by following and implementing the Kelkar Committee recommendations as P. Chidambaram professed to do on Monday.

The embattled finance minister even said volubly: “I am making this statement, so that everybody in India acknowledges the steps we are taking …..I sincerely hope that everybody will read this statement and will take note”. That everybody obviously did not include the RBI and its governor. Alternatively, they chose to ignore mighty Chidambaram.

Why did RBI do this and not comply with the government’s plea?

RBI’s credit policy has been guided by four risk factors, as it has noted in its statement. These are: threats to subdued growth, high inflation, twin deficit (that is, fiscal deficit and current account deficit) and possible liquidity crunch from government financial situation.

Hence, RBI has chosen to keep basic policy rates unchanged (to keep fighting inflation and subdue inflationary expectations), but has infused fresh liquidity (to provide credit to productive sectors). Asserting the central bank’s independence from the government is no doubt good. Why should a central bank play to the tune of the government without bothering to carry out its primary task?

But, independence apart, the central bank has a much larger charge as well. Why else, the US Fed should announce its decision to keep interest rates at present levels of close to zero or embark upon successive large and continuing bond purchase operations, now known as “quantitative easing”? They are doing these to ensure that the stalled growth process gets a little nudge. That employment levels increase and the rhythm of the economy is not altogether disrupted.

From such a point of view, the RBI seems to be extremely cautious, particularly in view of the fact RBI itself has noted that inflation trend has been on the lower side. Besides, it is known that food prices moderate in the winter months and even start falling.

RBI could have chosen to be more proactive and given some growth boosters to the economy. In his policy statement, governor Subbarao has noted that growth rates have steadily fallen over the years since April 2010 when it began its tightening of credit policy. In the growth-inflation dynamics, the RBI has weighed in for inflation control at the cost of growth. There are other points of view, of course, favouring growth a little more. It may be noted, another Nobel laureate economist, Joseph Stieglitz, has only recently underlined the importance of growth particularly in a developing economy and when facing serious global uncertainty.

But then, what are the reasons which weighed RBI down to its continuing restrictive policy. Let us look at these in a little detail from RBI’s point of view. Headline WPI inflation remained sticky at above 7.5 per cent on a year-on-year basis through the first half of 2012-13. Furthermore, in September there was a pick-up in the momentum of headline inflation, driven by the increase in fuel prices and elevated price levels of non-food manufactured products.

Non-food manufactured products inflation was persistent at 5.6 per cent through July-September and continued to exhibit upside pressures from firm prices of metal products and other inputs and intermediates, especially goods with high import content due to the rupee depreciation.

During April-August, the Centre’s fiscal deficit was nearly two-thirds of the budget estimate for the year as a whole. In view of evolving patterns of revenues and non-plan expenditure, the revenue deficit (RD) and the gross fiscal deficit (GFD) for 2012-13 are expected to be higher than budgeted. Even while prospects for agriculture appear resilient, the overall outlook for economic activity remains subdued. On these considerations, the baseline projection of GDP growth for 2012-13 is revised downwards to 5.8 per cent.

As regards inflation, the baseline projection for headline WPI inflation for March 2013 is raised to 7.5 per cent from 7.0 per cent indicated in July. Importantly, it is expected to rise somewhat in Q3 before beginning to ease in Q4. Although inflation has remained persistently high over the past two years, it is important to note that during the 2000s, it averaged around 5.5 per cent, both in terms of WPI and CPI, down from its earlier trend rate of about 7.5 per cent.

The large twin deficits, i.e., the current account deficit and the fiscal deficit continue to pose significant risks to both growth and macroeconomic stability. Liquidity pressures pose risks to credit availability for productive purposes and could affect overall investment and growth prospects adversely. On the other hand, excess liquidity could aggravate inflation risks.

Assessment of these risk factors cannot be very straight-jacketed. While RBI is looking at them as if the glass is half empty, it is also possible to look at them as the glass being half full. At least on some counts, the central bank could have taken a more positive view. The central point of inflation is surely now on the softer side and RBI could have taken a little more risk on its shoulder. (IPA Service)