Interest rate: RBI’s prerogative

Anjan Roy

There is this continuing spectacle. You ask for an interest rate cut from the in every season: when prices show a little drop; when the stock market goes up; and, when the government thinks growth is not as much as they would like it to be.
As the latest inflation print was released last week, the chief economic adviser, Arvind Subramaniam, had asked for a interest cut, criticising the RBI of committing errors in predicting inflation path. Later as the Index of Industrial Production (IIP) was given out, and it showed a drop in the industrial growth, the demand became more strident. And finally as the stock market touched new highs, there was renewed demand for interest cut to support the corporate sector and contribute to the continuing party.
If the central bank is pliable and cuts interest rates every time it is demanded, soon enough it would reach a point when it cannot possibly cut interest rates any further. Indeed, something of this kind has already happened; fortunately, not in this country, but elsewhere in the developed economies. US, EU and Japan all had cut interest rates in the hope that it will jack up economic activity. When their economies did not respond to tha stimulus enough, they went into negative territory, that is, you have to pay a small percentage for holding money with the bank or the central bank. Then it was realised that after all negative interest rates were not such a bright idea.
Interest rates have been bones of contention since sometime. P. Chidamabaram, as finance minister, had a running battle with the then RBI governor, P.V. Subba Rao, over interest cut just because the overbearing minister had thought any cut would automatically and instantaneously push overall growth rate thereby adding feathers to his already bloated cap. Fortunately, we had a RBI governor who refused to comply and even ready to join the war of words.
All that aside, do the figures really merit an interest cut just now?
Setting monetary policy, interest rate being the primary tool for that, is a complex job which has to take into account a slew of priorities. For the central bank, the first priority is price stability and all its actions are to be judged against that single and overarching consideration. Thereafter, you can think of a central bank as one of the institutions which promotes growth and stability of an economy.
Seeing the current situation from that primary concern regarding price stability, should RBI cut its interest rate now? The central bank has been tasked with inflation targets by the government and that target now appears to have been undershot. Current inflation rate is a little less than the targeted level. But should the policy rates be cut immediately it is less than the target. Does it merit some caution.
It looks as though it does. If you look into the fine print of the inflation figures, the rate is low because of the very low inflation rate in food articles. This behaviour of the food prices is rather uncommon. Year after year, food prices had shown rising trend at this time during the summer till October harvest. This is reasonable because availability of food items –particularly vegetables and fruits—go down. This time it is somewhat different and prices have been stable to low. Some items have fallen as supplies have jumped.
However, this is more due to temporary over-supply than a secular rise in production. More so, we have to wait for the overall behaviour of the monsoon which will determine the crop and the harvest and thereby the prices. So a re-look at the policy interest rates should be taken a little later when the monsoon had progressed, there is some clear idea of the trends in cropping and possible production. The issue will be how much of that production really comes to the market, rather than getting rotten.
Meanwhile, what should be taken care of now is how much stocking facilities are around as in the absence of that crop generally go waste. We have only recently witnessed how farmers had committed suicide following crash in prices of their crops (mainly vegetables and some food grains). The sad incidents gave rise to demands for bank loan waivers for farmers, which was the wrong move. Instead, it was important to drive home the point that there is need for cold storages and reefer vehicles for reaching the harvest fresh to the consumers.
These are important practical considerations. A hasty decision would exhaust the RBI’s options for taking the correct move at the right time.
As for interest rate policy, employment and inflation levels, there is rather free and casual mentions in the popular discussions –particularly on TV programmes—of complex concepts such as the “Philips Curve”.  The concept is loosely being used to refer to a possible trade-off between employment and inflation rate. However, it is not realised that this holds true only in very strict conditions where there are limits on production rise, among others. In a way, this should not apply to en economy like that of India, where production rise is not a constraint.
In one popular discussion even the changes in the methodology of national income computation was cited as reason for doubting the GDP figures. However, there would be no elaboration of why the changed methodology was showing an untrue GDP picture. These are verging on the presumptuous. As little of the nuances of professional statisticians or technical economists are really factored into these deliberations.
One can only say that leave the monetary policy to the RBI. They have enough expertise and one can refer to these from a very broad public affairs standpoint. (IPA)

Friday, 21 July, 2017