RBI not the only central bank to get inflation forecast wrong: Rakesh Mohan

Interview with former deputy governor of the RBI

Rakesh Mohan, who has been economic affairs secretary and a former deputy governor of the Reserve Bank of India (RBI), talks to Indivjal Dhasmana on some of his policy observations, ahead of the release of a book on economic reforms, edited by him. Former prime minister Manmohan Singh will release the book on Friday. Edited excerpts:
 

The book says that though economic reforms were triggered by the twin balance of payments and fiscal crisis, those were largely homegrown and were the result of technocratic consensus right through the 1980s. However, critics say that the reforms were thrust upon. Do you agree?

I don't agree with that at all. We need to look at the history of what went on in the government right from early 1980s to 1990s, from the time that Mrs Gandhi came back to power. A number of committees were set up by the government during that period. Right through 1980s, every Chairman of BICP, from Lovraj Kumar to  Y K Alagh to Vijay Kelkar, recommended doing away with administered prices and moving towards market determined ones.

During Rajiv Gandhi's time a number of industrial reforms were done, in terms of partial indusrial delicensing, but these were really homeopathic relative to what was done later. Similarly, on the trade side, more and more items were put on OGL in the late 1980sr. Finally, when VP Singh was the finance minister under Rajiv Gandhi, he set up a committee to suggest long term fiscal policy, which was announced in parliament.

My point is that right through the 1980s, there was not even one economic policy report which went against this trend.The recommendations in each of these reports were timid relative to what happened in 1990s, but there was an emerging consensus in technocratic sense and also certain small continuous actions.
 

The book also says that reforms were carried out without causing any major disruptions. How do you categorise demonetisation in that respect? Was it a reform? If yes, it caused major disruptions.
 

This book is really about first 25 years of reforms and does not address the present time. Time will tell whether demonetisation was a reform or not. It is little difficult to make a comment at present.
 

You talked about fiscal reforms when VP Singh was the finance minister. That time MODVAT came, which was predecessor to Cenvat and state-level VAT and now GST. How do you evaluate the present GST regime?
 

I think that this is a reform which has taken too long to implement. It has taken ten years from the time that the GST idea was conceived. It was essential to do this reform. However, it is a pity that we have five rates. The ideal would actually be a single rate or may be two rates at most. It is indeed difficult in a federal fiscal set-up to get such a consensus, in particular when the economic conditions are so disparate between states. In that sense, it is a major step forward. Who knows in the next few years we would be able to clean up the number different rates that are currently being levied. It is almost impossible to contemplate achievement of such a consensus among all the states and the federal government in the United States.
 

The book points out that agriculture has never caught imagination of reform managers. In that respect, how do you assess the current farm distress in many parts of the country and demand for farm debt waiver which five states have already announced?
 

Let me give you a broader view than the current issue of the farm debt waiver. The issue really is two-fold. We have not focused adequately on agricultural development itself on the one hand, and on the generation of non-farm employment on  the other.  We have clearly not done enough in terms of incentivising and promoting labour intensive manufacturing.

One of the expectations at the time of reforms in the 1990s and right through has been that, as we correct the customs duty structure towards neutrality between different goods, India's comparative advantage of producing labour-intensive manufacturing goods would manifest itself. as it did  in Japan, Korea  earlier and then in south-east Asia and  China. This has just not happened.  In that sense, it is not surprising that there is distress in agriculture. Second, consumption of agriculture produce has undergone a change as income of the people has increased over time. So, people have moved continuously from high consumption of cereals to more and more of fruits,vegetables, meat, milk, eggs, etc..However, our image of agriculture has not keep pace with this change.
 

You have talked about lack of labour-intensive manufacturing in India. How do you assess Make in India programme in that respect?
 

It is extremely important to have this kind of thrust on make in India. However, I have not seen policy measures which will actually make Make in India fructify. Yes, certain policy measures have been taken such as opening up of the defence sector to private investment, both domestic and foreign, but I don't really see significant industry wide measures to promote Make in India, particularly labour using industries. 

You talked about fiscal reforms and in that respect many say that farm debt waiver given by the UPA-2, coupled with stimulus package to industries, left adverse impact on fiscal imbalance over the subsequent years. Now, the demand for farm debt waiver is being made by farmers that could disturb states' fiscal balance this time. How do you see this?
 

I have not seen the numbers, so I would not be able to make a precise comment. Overall, I would say we need to be careful in taking any measures that erode the credit culture. Critics point to the  big guys who have resulted in huge non-performing assets of banks. We have to understand the causes for NPAs and demand for waiver in agriculture. In both agriculture and industry if there are exogenous reasons that led to distress, say drought in farms and excess capacity in steel, then the measures to address the sufferings should be thought of. But, if there are cases where exogenous factors are not there and people are defaulting, then different policy measures are required. 

You had worked in both the finance ministry and the Reserve Bank of India. Of late, there have been differences between them over the issue of formal meeting of the members of monetary policy committee with finance ministry officials, inflation forecasting etc. How do you see these differences?

There are always some degrees of tensions between the central banks and the finance ministries because they have different functions. It is natural. Sometimes these become intense, sometimes not that intense. In the case of the current situation, it is this government which has done monetary policy reforms, set up a monetary policy committee and has given an inflation targeting and monetary policy framework to RBI. This is a new situation, this is a new framework. It will evolve. But, it should be noted that it is the government that has given the  RBI this clear objective for monetary policy. The Governor is not a sole decision maker now: it is the independent MPC. The government itself has given these powers to MPC. So it must respect the institution it has set up and give it time to mature.

What about errors in inflation forecasting by RBI?

So far as inflation forecasting is concerned, most forecasting agencies in the world have encountered problems with inflation forecasting in recent years. This is as true of the IMF and of the US Federal Reserve.  They have been consistently wrong in expecting inflation to go up in the last couple of years. Despite continuing economic recovery in the North Atlantic, and labour market tightening, inflation is refusing to go up! We are not the only country where the central bank has gone wrong in forecasting inflation.