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Mr Ajit Dayal rightly highlighted a few points from the extracts of a letter that Dr Rajan sent to his colleagues in the Reserve Bank of India (RBI). This was after his decision to not continue for a second term.
Dr Rajan was outspoken pertaining to things such as inflation and wouldn't have compromised on the same by reducing interest rates. The government certainly didn't agree with this view and it led to the differences between the then governor and finance minister. This was one of the prime reasons leading to Rajan's exit.
Now the new governor, Dr Urjit Patel too seems to be a believer of keeping inflation at low levels. He produced the report that led to the RBI adopting its first formal inflation target.
Consumer prices are currently rising at a rate close to the top end of RBI's target range of 6% a year. Dr Urjit Patel is most likely to conclude that there's no scope for lower interest rates.
Now undoubtedly, there would be much pressure from the government to lower interest rates. In such circumstances, we hope that the new governor does not bow down to such pressures and continue the good work that Rajan has left behind.
Instead the government should focus on the following areas which can in-turn lead to lower interest rates.
Controlling food prices by improving poor rural infrastructure, fixing the supply side bottlenecks and incentives that encourage farmers to plant the right crops can help in curtailing food inflation.
The second is to adhere to a stronger fiscal discipline. One way to achieve this is to privatize the inefficient loss making state companies which would serve the dual purpose of raising money and making them more efficient. A stronger fiscal discipline will give RBI a leeway to cut interest rates.
Unless the government draws its efforts towards these things, it would be hard to bring down the interest rates. And in that scenario, if the government pressurizes the new governor on reducing the rates, Dr Patel too could meet the same fate as Dr Rajan.
For gaining a detailed perspective on this issue, we strongly suggest you read Vivek Kaul's recent article, The Biggest Challenge for the New RBI Governor Urjit Patel is...
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