Toughness of Regulator


I was surprised when the RBI (Reserve Bank of India) did not choose to drop its benchmark interest rate last week.

There were a couple of reasons for my optimism that the rate would indeed be reduced, albeit by just 0.25%, but nevertheless a concession to the economic growth imperatives facing India.

These reasons were: (1) The RBI cannot constrict growth that is badly needed for the country, in the name of trying to rein in the uncontrollable inflation – how long can they go on waiting for the inflation to come down ? and, (2) the pressure from the Government of India conveyed to the RBI Governor (undoubtedly) just prior to the RBI review meeting by the rather eloquent and precise gentleman that we have as the Finance Minister of India – Mr Chidambaram.

But the RBI did not buy the Government’s blueprint on fiscal consolidation and deficit reduction. It was anyway clear to everyone around (except may be the mandarins of the Finance Ministry) that with State Elections starting off and potential early Parliament Elections, the Government has to loosen its purse strings – which means more and not less subsidies !

The unique factor in RBI decision-making is the characteristics of the Governor who runs that august institution – for the past two decades, tough Governors have been running the show, the current incumbent being no exception. Though all the RBI Governors have come from the Government of India heritage (some of them also possess international economic experience in the World Bank or the IMF, etc.,), once they assume the position of the RBI Governor, their thinking and decisions change totally, keeping in view the demands and needs of their new job as the guardian of the monetary policy of India.

In a way, I was also not surprised. I knew that the inflation challenge combined with the fiscal deficit would make it very difficult for any decision to be made in favour of a reduction in benchmark interest rates. The reaction of the stock market in a negative manner was hardly a consideration, and should not be considered at all in such decisions. The RBI Governor did not mince words – he clearly put the onus on the Government for controlling the deficit within the plan of a 5.1% deficit target, and did not buy a 5-year plan target for reducing the deficit below 3% (neither he nor the current Finance Minister might be in their respective positions in 2017 !).

So, all this shows that governance mechanisms and philosophy do exist in India, although in specialized pockets of excellence. RBI is one such pocket of excellence and the Government of India has no choice but to live with the RBI as the economy needs to be jointly fixed.

Cheers,

Vijay Srinivasan
4th November 2012
Mumbai

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