The See-Saw Conundrum: How The Government And The RBI Need To Work Together To Tackle Both Inflation And Slowing Economic Growth

Posted on October 31, 2012 in Business and Economy

By Pradyut Hande:

Finance Minister, P. Chidambaram, may have come up with an ambitious Fiscal Consolidation Plan to reduce the growing fiscal deficit and in turn embark on a calibrated path towards accelerating economic growth; but the RBI’s decision to not lower interest rates appears to have dimmed some of the enthusiasm surrounding the development. It was widely speculated that the D. Subbarao helmed RBI would back the Finance Ministry’s renewed attempt at rekindling a stagnant economy. However, whilst commending the Government’s efforts, the RBI presently stands steadfast in its refusal to reduce interest rates in the face of rising inflation. Set in this backdrop, there appears to be a consequent face off between tackling the critical issues of both economic growth and inflation; with the Government and the central bank differing in their points of view.

A visibly annoyed Finance Minister openly declared, “If the Government has to walk alone to face the challenge of growth, well we will walk alone…” There may be just reason for him to be piqued. But let me examine this perceptible dichotomy in thought process and action plans from another angle. For starters, irrespective of the criticism coming his way, Subbarao deserves to be lauded for not buckling under populist pressure and maintaining the prevalent interest rates instead of dropping them as was widely expected. Tackling inflationary pressures is paramount on the RBI’s monetary policy agenda. Thus, the interest rates will remain the same, at least for this quarter.

Many believe that this throws a major spanner in the wheels of potential economic growth. But, instead of focusing merely on that aspect, naysayers would be better served taking cognisance of other aspects too. Now, although the current Repo Rate (the rate of interest at which other banks borrow from the RBI) remains at 8%; the RBI has made certain concessions by further reducing the Cash Reserve Ratio (CRR) (a stipulated requirement where banks have to maintain a fixed portion of their deposits with the RBI) to 4.25%. This would result in the availability of over Rs. 17,500 crores across banking channels, in the hope of decreasing the credit deficit and mobilise funds for investment in important sectors. This is actually the fourth time that the CRR has been decreased in the last 12 months alone. Although its benefits have been subliminal, a further reduction is expected to make more of a positive fund flow difference. Additionally, the RBI has also brought down the Statutory Liquidity Ratio (SLR) (a mandatory directive that requires banks to invest a certain proportion of their deposits in Government promoted securities).

Also, instead of continuing to focus on potential Repo Rate reductions, the key issue of Liquidity ought to be addressed. Without adequate liquidity in the system, no amount of increase or decrease in Repo Rates would make much of an impact. Enhancing liquidity is a major stepping stone towards resuscitating a slackening economy. While lowering interest rates in the long run is advisable, concomitant to the prevalent rates of inflation and economic growth, it isn’t the only way to spur growth. Dwindling liquidity is a clear indicator of a struggling economy. Thus, once liquidity in the entire system is gradually increased, there is greater stability and available avenues for investment.

The Government may have green lit a slew of diverse reforms in the past month and a half, but the RBI does not intend to reduce interest rates unless those reforms actually come to fruition, inspire greater investor confidence and begin to translate into tangible sectoral benefits. Instead of trying to pull away in opposite directions, both the Government and the RBI ought to devise a collective blueprint that would systematically counter inflationary pressures while not compromising on revitalising the economy. It may be easier said than done, but is definitely not an impossible proposition.

About the author: The Writer is a Business student with a degree from NMIMS, Mumbai. He is presently working as a Senior Executive with a leading Public Relations firm in Mumbai. Through his writing; he attempts to address myriad issues of both domestic and global consequence, ranging from Business and Economics to Geopolitics…from Sports to Arts and Culture. He has over 200 publications to his credit in some of the leading national dailies and weekly magazines across the country. He is also a keen debater, munner, quizzer, painter and amateur freestyle rapper. His other interests include Sports, Music, Reading, Travelling and Social Entrepreneurship. For his latest postings, follow his blog . To read his other posts, click here.