RBI boss delivers a parting kick Finger at loose govt stance

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By OUR SPECIAL CORRESPONDENT
  • Published 30.08.13
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TAKE A WALK, sir

Oct. 31, 2012

Growth is as much a challenge as inflation. If the government has to walk alone to face the challenge of growth, then we will walk alone

P. Chidambaram

After RBI governor D. Subbarao did not heed his advice to cut interest rates

aug. 29, 2013

I do hope finance minister Chidambaram will one day say ‘I am often frustrated by the Reserve Bank, so frustrated that I want to go for a walk, even if I have to walk alone. But thank God, the Reserve Bank exists’

D. Subbarao

In his ‘public farewell lecture’

Mumbai, Aug. 29: Outgoing RBI governor Duvvuri Subbarao today launched a blistering attack on the UPA government for failing to respect the autonomy of the “apolitical” central bank and trying to circumscribe its role.

Delivering his last public lecture before retiring on September 4, Subbarao said: “It is important that the mandate of the Reserve Bank of India is written into the statute so that it is protected from the political dynamics of changing governments.”

The statement is significant since Subbarao has always believed that the RBI was being forced to carry the can for the government’s failure to put its finances in order and frame appropriate fiscal policies to kick-start a stuttering economy and slam a lid on its burgeoning deficits.

The comments came on a day the markets stanched the bleeding and the Prime Minister conceded that domestic factors were also responsible for the economic “difficulty”. The rupee today soared by 225 paise to end at 66.55 against the dollar and the sensex jumped by over 400 points on the back of the RBI opening a special dollar facility for state-run oil companies.

The Federal Reserve in the US, for instance, has a dual mandate that is clearly spelt out: it must control inflation and ensure job creation.

Subbarao said: “Central banks make macroeconomic policy that influences everyday life of people; yet they are managed by unelected officials appointed by the government. Such an arrangement is deliberate, based on the logic that an apolitical central bank, operating autonomously within a statutorily prescribed mandate and with a longer time perspective, is an effective counterpoise to a democratically elected government which typically operates with a political mandate within the time horizon of an electoral cycle.”

In 1977, the US Congress amended the Federal Reserve Act, stating that the monetary policy objectives of the US central bank were to “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates”.

While doing so, the Fed must balance the “long-run growth of the monetary and credit aggregates” with the “economy’s long-run potential to increase production”. This is often called the “dual mandate” and guides the Fed’s decision-making in the conduct of its monetary policy.

With no clear mandate set out in the RBI Act, the government has been able to blame the Indian central bank and its monetary policy for all the ills that have beset the economy over the past 12 months.

“An autonomous and apolitical central bank is a delicate arrangement… and will work only if the government respects the autonomy of the central bank, and the central bank itself stays within its mandate, delivers on that mandate and renders accountability for the outcomes of its policies and actions,” the RBI chief added.

Subbarao also waded into the contentious debate over whether or not the RBI’s monetary tightening had driven down growth without squelching inflation.

He said it was “inaccurate, unfair and misleading” to attribute the moderation in India’s economic growth — which tumbled to 5 per cent in the year ended March 31 from 6.5 per cent in 2011-12 — to the RBI’s tight monetary policy.

Growth had slowed because of a “host of supply-side constraints and governance issues” which were clearly beyond the purview of the RBI, he said.

If the repo rate was the only factor inhibiting growth, he wondered why the economy hadn’t shuddered to life when the RBI cut the policy interest rate by 125 basis points between April 2012 and May 2013.

He said the critics of the RBI’s monetary tightening policy “must also note that our degrees of freedom were curtailed by the loose fiscal stance of the government during 2009-12”.

With the benefit of hindsight, he admitted that the economy would have been better served if the monetary tightening had started sooner and stronger. “I say that because we now know that we had a classic V-shaped recovery from the crisis (of 2008).” Growth had not dipped as low as feared after the Lehman crisis and growth in the subsequent two years had been stronger than earlier expected.

Subbarao said the RBI’s anti-inflationary stance in 2010 and 2011 should be evaluated against a backdrop where food inflation led to wage inflation and then blew up into core inflation. He said this transmission was institutionalised in the rural areas because of the rural job scheme, MNREGA, where “wages were formally indexed to inflation”.

The wage-inflation dynamic played itself out in the context of consumption-led growth, large fiscal deficits and implementation bottlenecks, creating a “potent cocktail for core inflation” which rose from 3 per cent at the start of 2010 to almost 8 per cent by the end of the next year.

He said it was misleading to attribute the speed and timing of the rupee depreciation in recent weeks to the so-called “tapering” of the US Fed’s quantitative easing programme.

The root cause of the rupee’s slump were domestic structural factors. “We have been running a current account deficit (CAD) well above the sustainable level for three years in a row,” he said. The CAD was estimated at $88.2 billion, or 4.8 per cent of the GDP, in 2012-13, far above the RBI’s comfort level of 2.5 per cent.

He said the only way to reduce the CAD was to finance it through non-debt inflows.

The outgoing governor said the mechanisms for the RBI’s accountability were also inadequate.

He suggested that India would do well to emulate the US example where Fed governor Ben Bernanke explains to the US Congress the nuances of the Fed’s monetary policy. “Perhaps, we should institute an arrangement whereby the governor goes before the parliament standing committee on finance twice a year….”

He also had a word for his bitter adversary, finance minister P. Chidambaram.

Subbarao said: "I do hope finance minister Chidambaram will one day say 'I am often frustrated by the Reserve Bank, so frustrated that I want to go for a walk, even if I have to walk alone. But thank God, the Reserve Bank exists'."