Raghuram Rajan's last hurrah

The government needs to plug the institutional gaps

As Reserve Bank of India Governor Raghuram Rajan prepares for his last monetary policy review on Tuesday, much has changed and yet much remains the same. Internationally, after an unexpected Brexit, market sentiment appears to have calmed down after the initial turbulence. Domestically, too, there have been several good portents. For one, after two back-to-back droughts, the monsoon has not disappointed this year. A normal monsoon holds the promise of a much-needed improvement in agricultural growth as well as rural demand. Elsewhere, too, consumer sentiment is up as witnessed by the surge in car sales in July. Last but not the least, after years of quibbling, the political parties finally passed the long-pending Goods and Services Tax Constitution (Amendment) Bill in the Rajya Sabha on Wednesday.

Yet, strictly from a monetary policy perspective - and this is the part that hasn't changed - there are renewed demands for an interest rate cut from Mr Rajan, the argument being that monsoon would bring down inflation and the RBI should adopt a more forward-looking approach and enable India's fledgling recovery to take root. But another aspect that hasn't changed is India's retail inflation, which started inching up over the past quarter. The June consumer price index-based inflation of 5.77 per cent is almost at a two-year high and significantly higher than the five per cent target set by the RBI for March 2017. Under the circumstances, especially with the Seventh Pay Commission award on its way, Mr Rajan is justified if he stays put on the interest rate.

But beyond the specifics of inflation, there is another reason why Mr Rajan is likely to refrain from cutting rates: Apart from the fact that RBI governors have traditionally avoided taking any rate action so close to the end of their tenure, the institutional uncertainty surrounding the monetary policy framework is an additional dampener. There are two parts to the emerging institutional vacuum. The first has to do with not knowing who will succeed Mr Rajan, who has barely a month left before he leaves office. Surely, the world's fastest growing major economy can do without the weekly speculation that has become commonplace. The second part of the institutional gap relates to the monetary policy committee (MPC) that is still to be constituted. The idea of setting up an MPC was first raised by the Urjit Patel committee in February 2014 and Mr Rajan has championed this cause. He has been keen to oversee this transition where decision-making about interest rates will be placed in the hands of a six-member committee headed by the governor. This is a system that has been adopted by several countries and is expected to stabilise inflation expectations in the future. On June 27, the government amended the RBI Act to provide the statutory basis for an MPC. However, there is little clarity yet about the search-cum-selection committee, which is to be headed by the cabinet secretary, to find the three government-appointed members. It is best that such institutional gaps are filled before long.