Pump-priming growth

Reserve Bank of India Governor Raghuram Rajan has opted to send an unequivocal message that as long as the domestic growth momentum remains tentative and price pressures don’t pose a threat to the central bank’s inflation target, monetary policy will remain accommodative. The RBI’s decision to surprise markets and cut the benchmark repo rate by a sharp 50 basis points to 6.75 per cent — the lowest level in more than four years — is the most emphatic signal that it stands ready to help boost domestic demand and investment. In saying that “more domestic demand is needed to substitute for weakening global demand in order that the domestic investment cycle picks up”, Dr. Rajan has underlined the fact that local demand and investment hold the key to sustaining an incipient recovery. Clearly, the U.S. Federal Reserve’s decision earlier this month to continue to maintain the funds rate near zero in the backdrop of heightened uncertainties in the global economy, including in China and the emerging markets, has fed into Dr. Rajan’s calculations. So has the fragility evidenced in the financial markets following the devaluation of the yuan. And slowing inflation appears to have made the central bank sanguine about price gains being unlikely to pose a near-term threat to the economy, prompting it to lower its Consumer Price Index inflation projection for January to 5.8 per cent.

That growth appears to have for the moment taken pre-eminence and been placed front and centre in the RBI’s reasoning for its policy decision is, however, cause for some concern. As central bankers down the ages have reiterated, there are two key elements that form the bedrock of any communication emanating from the monetary policy authority — consistency and credibility. It is the consistency of messaging that may now be questioned by critics. For, Dr. Rajan had, less than two weeks ago, flagged the risks of too much stimulus fanning inflation and deficits, stressed the importance of anchoring inflation expectations from a longer-term perspective, and cited the example of the meltdown in Brazil. Indeed, the latest policy statement itself acknowledges that inflation is likely to start accelerating for a few months from September as “favourable base effects reverse”. And the central bank goes on to stress the role that the government needs to play to ensure food price stability by proactively managing the supply side so as to head off any pressures. That Dr. Rajan has chosen to frontload monetary action and pass the baton to the government, the banks and industry — in order to help ward off inflationary risks, transmit the benefits of interest rate cuts to borrowers, including home buyers, and increase productive investments — could put at stake his best-regarded asset. And that asset is his credibility.

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