No top level changes in RBI are needed. Strong economic measures by the Modi government would automatically limit RBI's role to monetary policy
The Narendra Modi-led National Democratic Alliance (NDA) is going to form the new government shortly. For a country, trapped in never ending inertia in the context of critical policy decisions, the decisive mandate comes as a huge relief. It is expected that in the days to come, policy paralysis will give way to quick decision resulting in rapid economic development.
Much before election results were announced, Indian media was agog with the fate of Raghuram Rajan, the governor of Reserve Bank of India (RBI) in the event of the Bharatiya Janata Party (BJP)-led government coming to power. There were apprehensions that the new government will either clip the wings of the governor or a new governor will be appointed. What most of the people have failed to notice is the role of RBI as an institution in an era where the Centre takes strong decisive actions.
The development of an economy is often driven by a series of fiscal policy measures accompanied by monetary policy steps. These two measures need to be supplemented by adequate regulatory changes to give wings to the economy like attracting investments from both domestic as well as foreign players. But in event of government not performing well, the role of monetary policy starts acquiring significance of a larger than expected magnitude. It has been seen that when fiscal policy measures along with other critical decisions by the government stops working, monetary policy starts acting as the sole instrument of economic stability and growth.
This is what precisely happened in the Manmohan Singh-led United Progressive Alliance (UPA)-II regime, especially post 2010. The governance started paving way for populist measures and there were many instances of back and forth approach in the policy making. Foreign direct investments (FDI) in retail was a classic example of things going horribly wrong. The end result of this policy is known to us when FDI in retail failed to do anything tangible for the economy. A series of failures by the Manmohan Singh government resulted in economy suffering from high inflation, slowdown of growth and increasing current account deficit. This is why from 2010 onwards, there was an increased activism by the central bank in India when it took the mantle of managing the economy through harsh monetary policy measures realising that the government has started failing and inflation, growth and currency can be managed only by using instruments of monetary policy.
Now with the new government in place, there is a scope to start actions, which will result in the economy coming back on the growth path. The role of RBI in stabilising the economy and providing the necessary push for growth is likely to get reduced. This reduction is required as monetary policy cannot be the sole driver of growth in the economy. Government action on the following fronts can substantially reduce the larger the life image that RBI has acquired recently in our economy.
Tackle inflation by removing supply side constraints: Inflation cannot be controlled by just monetary policy measures. RBI has been trying to make inflation, especially food inflation, look like a demand side issue, which it is predominately a supply side constraint. India has enough food grains to feed its population but two critical issues have been pushing food prices high which are 1) supply change management of food grains and 2) pricing policy in the form of procurement prices.
The farmer gets Rs3 per kg for something like an onion, but the same product is sold for as high as Rs20 a kg in cities. So who is the real beneficiary of this price difference? The government needs to have a look at this. Aren’t middlemen and undesirable intermediaries pushing up the price? Similarly, the procurement price of food grains has always been a political issue often used to win voters. There is a need to have a serious look at the mechanism of procurement price and ensure that prices are not hiked arbitrarily.
Indian rupee will grow stronger by attracting more investments: Indian rupee has grown younger in last one week, only on the news that a new government is going to be at the helm of affair. This is quite in contrast to what we saw last year when there was carnage in the currency market and the Indian rupee went as low as Rs68 to the US dollar. There is very limited role for RBI to stabilise currency though it was prima donna managing the currency volatility. If the new government starts putting policy framework in place, the Indian rupee will get stable and keep on marginally appreciating for sometime. While this may not be good for exporters in the short term, in the long run it will provide the necessary boost to India. It is noteworthy that China has performed well on the export front in spite of a stable and appreciating Renminbi against the US dollar. We need to make industries competitive to help them grow their exports and not essentially though measures like depreciation of currency.
Forget repo rate, encourage growth: Economic growth and development are not slaves of repo rate (RBI's main policy rate at which it lends to banks). The RBI governor himself has stated many times that the rate of interest does not decide the growth rate in the country. While high rates of interest may act as a temporary bottleneck, right policy measures can still propel growth. The government needs to promote an investment climate, especially promotion of small and medium enterprises to push employment and growth. There is a need to build huge infrastructure across country and avoid delays, which often results in cost escalation. Infrastructure building has to be a private-public partnership.
While RBI will have a role in context of monetary policy measures, action on part of government will automatically dwarf the role of RBI. The central bank can definitely contribute as many central banks do in context of overall policy framework in the country and should not setting economic policy for growth. In the days to come, the government will decide what kind of role RBI has to play not by changing the governor or its key officials, but by initiating action.
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Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
