Wednesday, October 05, 2016

RBI's inflection point?

Any change in leadership of an organisation is bound to create some reorientation however mild it is. If the differences in the personalities are huge, the reorientation is likely to be stark. Are we witnessing such a development in RBI?

Raghuram Rajan and Urjit Patel may not be as different as chalk and cheese. Yet, they are not birds of the same feather. Those who were witness to the overt camaraderie between RR and UP during the monetary policy announcements are apt to suppose that Patel would follow the policy laid down by Rajan to prioritise certain measures to control inflation over uncertain steps to promote growth. Rajan was an inflation hawk and could Patel be drastically different?

On October 4th, Urjit Patel announced a 25 basis point reduction in the policy repo rate as if to prove that he has a mind of his own. He paid glowing tributes to external members of the Monetary Policy Committee (MPC) as being of 'outstanding pedigree'. Patel is as taciturn as Rajan was articulate. It is good that he is, for see what he said about the merits of MPC. "MPC members bring value and a diversion of opinion, which is what the MPC is about." Did he mean diversity of opinion? Further, if there was unanimity regarding repo rate cut, there could not have been any expression of healthy divergent thoughts.

Ashok Lavasa, the Finance Secretary, pronounced unadulterated nonsense when he welcomed the cut in repo rate as "a decision which will go down well with all sections of the economy." Does he really expect the savers to welcome reduction in deposit rates?

Rajan believed that the real policy rate (that is the difference between repo rate and CPI inflation rate ought to be between 1.5% and 2% Now the RBI has scaled it down to 1.25% to 1.5% This is sought to be justified in the background of negative interest rates being witnessed in some economies.

Central banks which have ushered in low / negative interest rate regime have no clue about what needs to be done hereafter to stimulate growth. They have been on a thoughtless slippery path. Raghuram Rajan repeatedly cautioned against such unconventional policies which would be very difficult to wind down. Urjit Patel perhaps is not convinced.

Reduced cost of borrowing will be inflationary through the aggregate demand side though its stimulatory impact on growth is uncertain. Demand for lower interest rates is addictive and we can expect more clamour for further reductions. In the meanwhile, senior citizens who depend on interest income will continue to be left in the lurch.

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