While monetary and fiscal policy makers grapple with the “growth versus inflation” debate to determine India’s economic future, they should give top priority to finding a way out of the current mess in the banking system and improve the private investment cycle.
This was the key message that came out of a panel discussion with former Governors of the Reserve Bank of India C. Rangarajan and D. Subbarao and the former Deputy Chairman of the Planning Commission Montek Singh Ahluwalia.
“The most important thing that we need to do is to get investments. Monetary policy alone cannot bring growth. Investment rate is falling. So we need to do a whole lot of things to bring investments,” Dr. Subbarao said during the panel discussion moderated by R. Srinivasan, Editor, BusinessLine .
Need to fix banking system
Mr. Ahluwalia said that in addition to improving the investment cycle, the banking system needed to be fixed.
“There should be high priority in resolving the banking mess that has been created over the past three or four years. The banks should get back to lending. This is not a monetary policy issue. Clearly, the RBI and the government have a role since 70% of the banks are still public sector banks,” he said.
Asked what should be done by policy makers going forward, Dr. Rangarajan prescribed consultation with industry to see how the investments could be brought in.
“It is obvious that the economy is performing below potential. The economy can grow at 8-9%. Monetary policy will not be able to do much here to stimulate growth. Even if the interest rate is lowered, I am not sure if the banks are in a position to pass it on. They have other problems like NPAs [non-performing assets]. The government also cannot raise the public investment by more than a few decimal points,” Dr. Rangarajan said.
“The private investment rate has fallen from 33-34% of the GDP to something like 27%. Government should call the industry and find out what is really coming in the way of higher investments. More focussed attention to individual sectors of the industry would be a good thing to do,” he said.
Dr. Subbarao said the ongoing inflation targeting framework had worked well so far, but had not been tested.
“The test will come when the growth is low and inflation is high. It has worked reasonably well so far, but it has not been tested. Test will also come when there is capital inflows, when there is pressure on the exchange rate. What will the RBI do then? Will it control the inflation or will it manage the exchange rate? These are the questions for which one cannot lay down the rules and one needs to play it by the ball as per the situation,” he said.
Mr. Ahluwalia criticised the Centre’s move to increase customs duties. “Domestic production can be better protected by having a more realistic exchange rate rather than increasing the import duties. It is a very regrettable step,” he said.
Dr. Rangarajan said that while growth was important, it had to be consistent with some level of stability to make the growth sustainable. “You cannot have inflation at 7-8% and then say growth is important.”
'Policy makers always in dilemma'
Mr. Ahluwalia said that policy makers were always in a dilemma. “In reality, politicians have a tough job because they are interested not just in keeping inflation low, but they are interested in lower inflation in every commodity. The Finance Minister will be terrified of a news item that says prices of onions have shot up, even if other agricultural prices are low,” he said. There was excessive focus on monetary policy to drive growth.
“We are upset that the RBI is following the rule, but we don’t seem to mind that the fiscal deficit has been departing from the rule. If you ask which part of the economy is not following the rule set a few years ago, then it is clearly the fiscal deficit. We keep postponing the deadline to meet the fiscal deficit targets. It is difficult to understand why it would depart from the rule next year if GDP is growing at 7.5% and the tax structure has stabilised. So the destabilising influences are not just on the monetary side but also on the fiscal side,” Mr. Ahluwalia said.