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RBI governor: Wizard of Communication - Outside View by S.S. TARAPORE

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RBI governor: Wizard of Communication
Nov 18, 2013

Reserve Bank of India (RBI) Governor Raghuram Rajan, in his short stay at the RBI, has decisively proved that he is a communicator nonpareil. His relaxed style of communication seems to soothe frayed market nerves. While he readily shares his thoughts, there is the danger that market participants and the media could keep asking for more.

It is unfair to expect Governor Rajan to produce painless solutions for all the ills of the Indian economy. Furthermore, with a dainty dish of problems on his table, he cannot be expected to reveal all his cards when reptilian market forces are out to gain from every policy move, by getting advance information under the ruse of 'forward guidance.'

Market participants have to recognise that good communication does not imply that the Governor must commit his policy responses in advance in a rapidly changing market environment.

The dish of problems

The foremost problem for Governor Rajan must be the high Consumer Price Index (CPI) inflation of 10.1 per cent on a year-on-year basis, for October 2013. Food inflation is soaring, with vegetable prices ridiculously high, at 45 per cent, on a year-on-year basis.

An obvious answer to the intolerable inflation would be to unload a sizeable part of the public sector food grain stock. With the bumper kharif crop, there would be insufficient covered storage to accommodate the new crop of rice, unless there are large releases in the domestic market and exports.

It is well-known that there are severe political economy constraints on policy action. While resolving the food grain problem is not the remit of the RBI, Governor Rajan is well aware that the blame for high retail inflation will be directed to his office.

The sluggish growth of industrial output would put pressure on Governor Rajan not to tighten monetary policy, yet overall inflation and external sector management imperatives would call for a tighter monetary policy.

Recent developments in the external sector give some comfort, with the step-up in exports and the deceleration of imports, but the slightest possibility of a faster tapering of the US Quantitative Easing will set the exchange market in a tizzy.

Easing of the CAD financing

Governor Rajan, in his press conference on November 13, 2013, revealed that the latest estimate for the balance of payments current account deficit (CAD) in 2013-14 could be of the order of US $ 56 billion (slightly less than 3.0 per cent of GDP).

He exudes considerable confidence that the CAD problem is well under control. An important piece of information revealed by Governor Rajan is that the oil marketing companies' demand for dollars is back on the market. He has further clarified that, if necessary, the oil companies' payments to the RBI could be in rupees rather than dollars, which should ease pressures in the exchange rate.

The RBI needs to make a careful assessment of the broad level of the exchange rate it can comfortably manage without pressure on the forex reserves. Furthermore, props like dollar swaps should not be extended beyond November 30, 2013. It is best that these props are removed before the eventual US tapering.

CAD and Gold

Governor Rajan is fully aware that the recent improvement in the trade balance is essentially because of stringent measures to curb gold imports. As regards the size of smuggled gold, the authorities are prone to underestimate the figure.

Although smuggled gold does not reflect in the trade balance, it reflects in the CAD as inward remittances are lower as they would be used to finance the smuggled gold. It is well-established that international data on gold destination-wise imports would give a reasonably accurate number for the extent of smuggling.

Absence of measures to mobilize domestic gold hoards

A notable feature of recent policy initiatives is the total absence of measures to mobilise domestic hoards of gold. The authorities appear to be averse to mobilising domestic hoards of gold at attractive rates of interest, perhaps because they fear that it could stimulate imports of gold and implicitly, the authorities accept gold as an instrument of saving.

This is erroneous. Mobilising domestic hoards of gold would reduce gold import demand. The costly mistake made in 1993 was to back off from setting up the Gold Bank, which had been announced in the February 1992 Budget. Not setting up the Bullion Corporation of India (BCI), as proposed by the KUB Rao Working Group would be a repetition of the mistake made twenty years ago. The government and the RBI should give serious attention to setting up the BCI.

Monetary policy and inflation

Inflation control is the central remit of monetary policy. Concerns about growth are important, but monetary policy has to ensure that at the margin, inflation control overrides growth concerns. Governor Rajan should not yield to the seductive sirens from industry crying over every small increase in policy interest rates.

The period between now and May 2014 will be crucial in the management of inflation. While refraining from sledgehammer measures, Governor Rajan should use every window of opportunity to increase policy interest rates in a calibrated manner.

He is decidedly the Wizard of Communication and while undertaking policies for monetary correction, he should use his persuasive skills to calm the nerves of markets.

I do not tire of repeating the celebrated statement by India's foremost monetary economics academician, P R Brahmananda, who said: "Not caring about inflation is like going into battle without caring for the wounded, the dying and the dead."

Please Note: This article was first published in The Freepress Journal on November 18, 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.


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