Monetary policy challenges

The RBI governor has outlined his views on key issues

Reserve Bank Governor Duvvuri Subbarao has kept his counsel these past 10 months, even as he has gone about his quarterly policy reviews, and some ad hoc announcements in between. Perhaps his first serious assay to address contemporary questions in monetary management was at the JRD Tata lecture organised by Assocham last week. Dr Subbarao dwelt on global as well as domestic issues, and his remarks are worth notice. Most importantly, he has come out firmly against inflation targeting as a single-point monetary objective (as recommended by, among others, the Percy Mistry committee). Instead, he favours the multiple-objectives approach that has defined RBI actions for at least the last dozen years, on the basis of well-founded reasoning that he has spelt out. For instance, inflation in India is not always a monetary phenomenon, especially when it comes to food items. Then, as he puts it, “The monetary transmission mechanism in India is impeded because of the large fiscal deficits, persistence of administered interest rates and illiquid private bond markets. Inflation targeting can be efficient and effective only after monetary transmission becomes streamlined.” Under Dr Subbarao, it is clear that RBI will continue to focus on real economic growth and financial stability, apart from price stability.

In surveying the international scene, the governor has noted with concern that the issue of dealing with global imbalances is not getting any attention. To quote Dr Subbarao, “Notwithstanding reams being written about resolving the present crisis and preventing another like this, global imbalances are not on the radar screen of policy debate. This is both perplexing and disturbing. Indeed, once the immediacy of the crisis is behind us, it will not be surprising if we head for another round of destabilising global imbalances.” Indeed, the governor recognises that global imbalances are inevitable (since some countries will have trade surpluses and others will have deficits); the question, he correctly points out, is how to prevent such imbalances from building up to destabilisation levels.

On fiscal and monetary policy, Dr Subbarao puts forward the thesis that the large fiscal deficits that the advanced economies have used to prop themselves up during the crisis will not disappear in a hurry, and that they are likely to persist for some time. On the domestic front, it is clear that the scale of the government’s sharply expanded borrowing programme bothers him, for he says: “The increased fiscal deficit is going to pose more than a proportionate challenge. Creation of high power money in the face of large fiscal deficits, even if there is no direct primary financing, is not costless; it can sow the seeds of the next inflationary cycle. The challenge for the Reserve Bank is to maintain a comfortable liquidity situation while at the same time anchor inflation expectations.” The message that comes through from the address is that the governor is not very sanguine about the management of the global economic system, and he has some worries on the domestic front as well.