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RBI Governor Rajan's ordeal by fire - Outside View by S.S. TARAPORE

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RBI Governor Rajan's ordeal by fire
Sep 10, 2013

Raghuram Rajan, the internationally acclaimed economist, has taken charge as Governor of the Reserve Bank of India (RBI). Thirty years ago, Manmohan Singh had said that the RBI Governor holds the loneliest job in the country. He has to resolve irresolvable problems and has no one to turn to.

Ordeal by fire

Raghuram Rajan could not have taken charge as governor at a more difficult time. He has to deliver low retail inflation, high growth, massive increase in employment, low interest rates for industry, attractive rates of return for savers, a strong rupee exchange rate, while at the same time rectifying the large, unsustainable balance of payments current account deficit (CAD). While tackling all these formidable problems, Governor Rajan also needs to give primacy to the aspirations of the common person. It would be an understatement to say that he faces an ordeal by fire.

Bringing down retail inflation

The world over, inflation is measured by the Consumer Price Index (CPI), yet in India, the Wholesale Price Index (WPI) is used as an indicator of inflation. It is erroneously argued that the CPI is a relatively new creature, that the CPI has a very large weight for food and fuel, and above all, WPI inflation would show a lower rate of inflation. It is the CPI which is relevant for the common person and it would be best to ab initio go for the hard option, as it gives a better indication of the dimensions of inflation. When it comes to determining the dearness allowance for government employees, as also indexing capital gains, it is the CPI which is used as the indicator. It would therefore be unconscionable not to use the CPI when formulating and monitoring monetary policy. It would be forcefully argued that food and fuel inflation cannot be tackled by monetary policy and, therefore, the RBI should stay away from the CPI. While it is admittedly true that government has to deal with structural issues, the RBI should also use all its instruments to contribute to the war against inflation. While fine tuning monetary policy, Governor Raghuram Rajan would, hopefully, recognise that savers need to be adequately remunerated and every opportunity needs to be taken to safeguard savers.

The RBI needs to be steadfast in its commitment to control retail inflation and not be persuaded by seductive sirens pleading for relaxation of monetary policy. In fact, the war on inflation requires, at the present time, a sharp tightening of monetary policy. There are, admittedly, serious problems, at the present time, in implementing a sharp monetary tightening, but the least the RBI could do, is to stoutly resist pressures to relax monetary policy. All that an easy monetary policy would deliver, is a rise in inflation and a reduction in financial savings, which, in turn, would widen the CAD. Thus, bringing down retail inflation should be the paramount objective of RBI's monetary policy.

Reducing the CAD

The government has explicitly stated that its objective would be to reduce the CAD from 4.8 per cent of the GDP (US $ 88 billion) in 2012-13, to 3.7 per cent of the GDP ( US $ 70 billion) in 2013-14. While the government is preoccupied with financing the CAD, the RBI's focus should be on curtailing the CAD.

The RBI should let the exchange rate settle where it does and should not use artificial props to claw back the recent depreciation of the rupee. The shifting of the oil companies' forex demand from the market to the RBI would result in an appreciation of the rupee, but would denude forex reserves and as such, should be quickly reversed.

For the past decade, the mantra of the RBI has been to control 'volatility' of the exchange rate. To the extent the RBI is committed to controlling 'volatility,' it should match spot sales by forward purchases or undertake buy-sell forward transactions. If there are violent bouts of appreciation, the RBI should not hesitate to undertake outright purchases to build up forex reserves. There is little merit in declaring a policy of a market determined exchange rate and then distorting the market by measures to prop up the rupee on the ruse that the RBI is containing 'volatility.'

When the rupee depreciates, more rupees are sucked out per unit of foreign exchange and as such depreciation per se is not inflationary. Yet blatant statements are made that the currency should be kept strong, as it combats inflation. A depreciation of the rupee is an expiation for the sins of the past, which corrects the disequilibrium. A country with a large, unsustainable, CAD just cannot afford to have an over-valued currency. On the contrary, countries have benefitted by an under-valued currency, the prime example being China. A depreciation of the rupee would greatly benefit medium, small and tiny industries, as their products become competitive in foreign markets. Moreover, domestic industry is better able to compete with imports. Large industry, which is generally import-intensive, is a beneficiary of a strong rupee. Large industry is articulate and better able to influence policy to its own interests, which may not be to the benefit of the country as a whole.

Mobilisation of idle domestic gold

The RBI's KUB Rao Working Group had recommended that a Bullion Corporation should be set up to mobilise domestic idle gold hoards. The Report was ostensibly under examination in the government and the RBI. Some press reports indicated that the Bullion Corporation was being set up. The August 31, 2013, press release by the RBI is rather baffling. It is one thing if the authorities felt that the announcement was premature and quite another if the very idea has been killed. If it is the latter, it would be a setback to rectification of the large CAD. A similar proposal was scuttled 21 years ago. If we do not learn from the mistakes of the past, we will be punished by the future. One hopes the KUB Rao Report will be seriously examined by Governor Rajan.

Tip of the iceberg
The above discussed issues are merely the tip of the iceberg. Let us wish Governor Rajan all success in his ordeal by fire.

Please Note: This article was first published in The Freepress Journal on September 09, 2013. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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