Rajan does a Subbarao, sacrifices growth to control inflation

By increasing repo rates, Rajan has punctured one more hole in the wheels of growth

Having won the battle (but not the war) against currency volatility, RBI governor Raghuram Rajan had two more targets in front of him-rising inflation and slowing growth. In the recently announced policy, he has chosen to train his guns at rising inflation.

Rajan has continued fine tuning the economy by increasing the repo rate by 25 basis points and at the same time cutting the Marginal Standing Facility (MSF) by a similar amount. In musical terms, his actions are akin to increasing the volume (treble) and reduce the bass. Net result- you get to hear the voice without being overpowered by the surrounding music. And the governor’s voice that comes out clearly says that he would fight inflation no matter the cost (to growth).

Rajan seems to have conceded his fight for increasing growth rate. This has been left to the government who will have to bring in the right kind of policies and confidence building measures that can incentivise investments. Rajan however has mentioned that he hopes that growth will pick up on account of revival of large projects and the clearance of pipeline by the Cabinet Committee on Investment (CCI). However, neither PMI data nor non-food credit flow betrays a pick-up in activity.

 

That brings us to the current battle between the governor and inflation. By increasing repo rate, Rajan is trying to strangulate inflation and hope to squeeze the life out of demand, especially during festive season. This however, does not match the finance ministry’s step of allowing subisidised money to consumers during the festive season. Thankfully, finance ministry’s  measures are restricted to PSU banks while RBI’s measures will be applicable to all banks.

 

In any case, persistent and sticky inflation is a result of supply side problem rather than demand. So is the governor shooting at the wrong target? Not quite.By trying to curb demand, he is allowing supply side to catch up with the reduced demand. But that’s like shooting a tank with a pea shooter. External environment does not support suppliers to increase their capacities. Unless this is handled, inflation, both food and non-food are likely to remain high.

 

Though RBI governor might put up a brave face and attempt to control inflation, there is very little he can do. By increasing repo rates, he has punctured one more hole in the wheels of growth. It is only through growth that he can hope to win not only the battle but war against inflation. At best,he is hoping to arrest inflation at the current level, and hoping that reinforcement in the form of growth will come and rescue him.

 

But the second quarter policy has nothing in it to help revive growth. Rajan is following his predecessor, D Subbarao’s footsteps in fighting inflation and sacrificing growth. We very well know where this policy landed us. For that, we will have to wait for his development policies to be unveiled. Till then we will continue to move with the governor’s foot on the brake pedal.