Prime Minister Manmohan Singh’s remark that the time has come for revisiting “the possibilities and limitations of monetary policy in a globalised and fiscally constrained economy” has been read by many analysts as his disapproval of the RBI’s actions over the last few weeks in severely tightening short-term liquidity and bringing some capital controls which had ended up causing panic selling in the stock markets last Friday.

However, some of Dr. Singh’s close advisers, past and present, who were present when the PM made the remark, have said that he was speaking in a broader context of globalisation and did not mean that the RBI must “revisit” the way it is presently conducting the monetary policy and managing the volatility in the rupee’s exchange rate. Both Dr. C. Rangarajan, the Chairman of Prime Minister’s Economic Advisory Council (PMEAC) and Y.V. Reddy, the former RBI Governor, who were present at the function, told The Hindu that Dr. Singh was speaking in the context of the historical evolution of monetary policymaking. It had little to do with what the RBI was doing in the current situation.

The Prime Minister, who released the RBI history volume in the presence of the central bank’s top brass and many former governors, including Bimal Jalan, in his brief address did say there was a need to revisit the possibilities and limitations of monetary policy in a globalised and fiscally constrained economy.

His intent was perhaps misread because of the recent intellectual disagreement between the Finance Ministry and the RBI in regard to the precise nature of the central bank’s mandate. The RBI has for the past two years been criticised for focusing excessively on inflation at the cost of growth. RBI Governor D. Subbarao made it a point to mention at the book release that it was “inaccurate and unfair” to suggest the RBI was only focused on inflation. He said the RBI was focused on inflation precisely because “it cared for growth”.

Mr. Subbarao also said that when he became Governor, the Prime Minister had advised him to keep his ear to the ground and ensure that the RBI’s policies catered to the ground realities of India. “I have tried to do this to the best of my abilities,” he added.

Mr. Subbarao’s statement came just a few days after Finance Minister P. Chidambaram told Parliament that though the RBI’s mandate was price stability it had to be seen in the larger context of growth and employment generation. The Minister also drove home the point that as per the Act of Parliament under which the RBI was born, the central bank was expected to actively consult the Centre on a range of matters even though it had implicit autonomy in monetary policymaking.

Whatever various authorities may say publicly, the fact is the Centre does hold the view that the RBI has not done enough to boost growth even after the GDP had slipped dramatically to less than 5% over the last reported quarter. Dr. Singh too may have wanted the RBI to cut interest rates more sharply after the budget announcement this year when things appeared to have stabilised and the RBI was, in fact, adding a few billion dollars to its reserves between February and May.

After this year’s budget, when there was some promise of fiscal correction shown by the government, the RBI did begin to relent a bit on easing rates. But this was short-lived as in recent weeks the perception worsened about India being able to easily fund its Current Account Deficit. The rupee started coming under pressure and the RBI found another “valid reason” to raise short-term interest rates, rather than reduce them to boost growth. In fact, the RBI does not accept the view expressed by the Prime Minister recently that the short-term liquidity tightening is a temporary measure and may be soon reversed. The RBI’s July 25 policy did not, therefore, reflect what the PM had said. Consequently, we may have to live with an effective 3 per cent hike in the short-term interest rates.

On his part, the Finance Minister has taken a slew of initiatives over the past two weeks to create confidence about being able to meet the CAD through adequate capital flows. He even told Parliament that India will have enough capital flows through the recently announced initiatives, and will add to the forex reserves at the end of the fiscal rather than draw from it.

It is politically important for the UPA to bring back confidence in the economy in the months ahead as India prepares for elections. It is in this context that the Prime Minister said on Friday that there was no question of India facing a 1991-like situation. Even the RBI top brass has signalled there would be no need to go to the IMF. The sheer irony is that in 2009, the RBI bought 200 tonnes of gold (worth over $9 billion today) to increase its gold reserves as a hedge against the dollar volatility. Is it being advised to reverse that transaction to curb rupee volatility?

The outgoing Governor did hint, in his address at the Prime Minister’s residence, that we could perhaps revisit the validity of buying 200 tonnes of gold from the IMF in 2009.

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