As recently as last week, the RBI made clear that it will stick to its anti-inflationary stance despite censure from the government, which has signalled that 12 rate increases within 18 months are hurting growth and electoral prospects.
Inflation is near 10%, one of the highest among major economies in the world. India is among a handful of countries, such as Kenya and Nigeria, still raising rates, while the world frets over headwinds from a European debt crisis and a sputtering US economy. Neighbours in Asia have turned dovish, some such as Brazil and Turkey have already cut interest rates. Subbarao appears undeterred by the criticism. RBI sources say he is determined to keep policy tight, maybe even tighten it further. Growth has a floor, but inflation has no ceiling, said a senior RBI official. If we dont do anything, inflation expectations will rise.
Until now, the government and the RBI have largely been on the same page when it comes to monetary policy, with near double-digit inflation not only an economic worry but also a political headache. But over the past few weeks, criticism and advice for the RBI chief have been more blunt than usual.
"I have had hesitation on a rate hike this time which in the past I did not, said Kaushik Basu, chief economic advisor to the finance ministry, after the RBI raised the repo rate by 25 basis points on Friday.
"I would personally, yes, vote for pause, he told reporters, when asked what the RBI should do at its October policy review.
Basu is a top adviser in the finance ministry and is known to be not only close to finance minister Pranab Mukherjee, but also a key strategist on economic policy. Basu has asked RBI to think out of the box and consider the examples of Brazil and Turkey that cut rates to protect growth. Montek Singh Ahluwalia, deputy chairman of Planning Commission and Prime Minister Manmohan Singhs close advisor, also questioned Subbarao's monetary actions. "You need to ask yourself whether interest rate is the best instrument to bring inflation under control. Are there other instruments" Montek said.
Pranab Mukherjee had hinted early this month that RBI should stop tightening monetary policy, an indication that the government was worried about the impact on growth. The government fears it may have a political cost to pay when Uttar Pradesh goes to the polls next summer, widely billed as the semi-final before the 2014 general elections.
Indian industry is worried about margin pressures while the anger of the vast Indian middle class, already at a high because of a price hike in petrol and high food prices, is now boiling over as home buyers and borrowers shell out higher instalments.
Subbarao is guided by other factors. RBI-watchers say he would not like to leave behind a legacy of unhinged inflation, even if it means risking the displeasure of his political bosses. Between a below 8% growth and 9% inflation, we choose to contain inflation. That is the net decision, said another senior RBI official.
There are some in his fraternity who understand his dilemma and are willing to back him. C Rangarajan, a former governor of RBI and a close adviser to the PM, is one such person. The RBI governor is right, as any monetary authority, to be concerned about inflation and his priority is fighting it. Rightly so, because inflation is high", said Rangarajan.