The latest Currency and Finance Report of the Reserve Bank of India takes justifiable credit for the way the Indian monetary authorities have steered the country through all the challenges and pitfalls that have been around since the nineties. | |
| India chose to undertake the most far-reaching structural adjustments in its independent history precisely at a time when the rapid progress of globalisation heightened the risk of instability which could derail the reform process. |
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| In the event, the Indian system performed admirably. While through the same period China has chalked consistently higher growth rates, the Indian system has tackled inflation better than the Chinese. |
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| The Asian crisis, its fallout on Latin America and Russia, the sanctions introduced after the Indian nuclear tests and the aftershock of 9/11 have all been taken in stride while maintaining above average growth rates. |
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| The Indian decision to go easy on capital account convertibility is today readily acknowledged as sound after learning the lessons from the Asian meltdown, but at that time it was touch and go. |
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| So what does the future hold and how best can the Indian monetary authorities innovate without losing balance? The most recent challenge is the price rise, which has marked a good part of the year about to end. |
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| Until very recently, the inflation rate was climbing almost alarmingly. But in the last few weeks there has been a deceleration, thus vindicating the steady hand at the helm, which did not react excessively and maintained the stability of policy. |
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| Two-fold challenges lie ahead. There is near euphoric confidence all round, which has every chance of sending asset prices sky high and creating a bubble, not tomorrow, but maybe the day after. |
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| The challenge is to restrain exuberance without jeopardising the prospects of sustained high growth. The second challenge will come from the fiscal side. Montek Singh Ahluwalia's suggestion that we put to good use the foreign exchange reserves to give a sharp forward push to infrastructure spending meant courting higher deficits. |
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| If that debate is somewhat over, the employment guarantee law will be capable over time of putting fresh pressure on the fiscal balance. Absorbing that, while allowing the government to exercise its perceived mandate, will be an important challenge in the medium term. |
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| The report notes that prudent fiscal policy is the greatest bulwark of a stable monetary policy and foresees a new era in monetary-fiscal interface with the Fiscal Responsibility and Budget Management Act in place. |
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| Strict adherence "in letter and spirit" to its rules will keep inflation low, while providing increasing flexibility to the monetary authorities. |
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| If fiscal management is very robust then undoubtedly the task of monetary management is made easier. But are we seeing a shrinking of the discretionary space of monetary policy with the concurrence of the monetary authorities? |
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| The report says that there will be interest rate cycles and this should not be confused with a lack of financial stability. And to cope with this, it asks everyone to suitably hedge the risks. |
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| It seems the RBI sees its role as one of keeping a close watch on pressure points and responding quickly but not excessively with the twin weapons in its command""liquidity management and interest rates. |
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