Helping You Build Wealth With Honest Research
Since 1996. Try Now

MEMBER'S LOGINX

     
Invalid Username / Password
   
     
   
     
 
Invalid Captcha
   
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Will Rajan continue to have his way?
Mon, 2 Jun Pre-Open

The Reserve Bank of India (RBI) has often been praised for its efforts to fight inflation. Last year the UPA government appointed Raghuram Rajan as RBI governor. Contrary to the initial expectations, he has proven himself to be an inflation hawk. He shocked the markets with interest rate hikes last year in a bid to keep a lid on inflation and contain expectations of sustained high inflation. So far it appears that his efforts are paying off. Consumer Price Inflation (CPI) is down from levels above 10% last year to a little above 8% now. The rupee has also stabilized and the RBI has put in a host of measures to improve monetary stability.

While performing his duty quite boldly, the RBI governor had to contend with the fact that the government was not always on his side. His disagreements with the then Finance Minister P. Chidambaram were well documented. He received a lot of negative criticism that he was unduly focused on fighting inflation using interest rates. Yet Raghuram Rajan stuck to his guns and even ticked off Indian corporates for demanding a cut in interest rates. Now that the country has a new government there has been a lot of speculation about the growth-inflation tradeoff. The BJP led NDA government has been elected to power on the basis of its promise to revive the economy. This will mean that the government will have to create jobs on a large scale. Labour intensive jobs are usually in the manufacturing and infrastructure sectors. The new government is expected to give a push to these sectors. However, it is likely to run into a serious problem very soon. Many infrastructure projects and green field manufacturing plants require significant debt at the time of starting off. This debt is paid off when the plant/project is up and running. But if the interest rate is sufficiently high, then many projects will be rendered unviable. This is the primary reason that will cause strife between the new government and the RBI.

Governor Rajan is unlikely to tone down his hawkish stance and has already made his views public. He has even stated the "the government can fire me but the government does not set monetary policy". On the other hand the new Finance Minister is certainly not a hawk as far as inflation is concerned. His mandate is to kick start the growth engine of the economy. It is our view that in the larger interest of the country, the Finance Minister and the RBI governor should work together to achieve economic growth coupled with low inflation. This can be achieved if the government were to push through reforms that would encourage entrepreneurship and reduce bureaucratic hassles. This would leave the RBI free to perform its primary task of containing inflation.

Do you think the new government will lean on the RBI to cut interest rates? Share your views on the Equitymaster Club

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

Read the latest Market Commentary


Equitymaster requests your view! Post a comment on "Will Rajan continue to have his way?". Click here!