The Reserve Banks Macroeconomic Concerns

Updated: Nov 7 2003, 05:30am hrs
The policy autonomy of the German Bundesbank has always been the envy of central bankers across the world and the President of the Bundesbank knows this. His favourite taunt to his European colleagues used to be that not only is his office located in a city different from the national capital (Frankfurt and not Bonn or now Berlin), but that even his office window opened to the south, a direction away from Bonn or Berlin!

The governor of the Reserve Bank of India could claim that too. Not only is his office further away from the political capital than Frankfurt from Bonn and Berlin, but even his office window opens to the south and not in Delhis direction! Aware of Mumbais independent mind on so many issues, New Delhi made a habit of picking governors for the central bank after they had a stint on Raisina Hill.

Even deputy governor C Rangarajan had to come to Delhi and earn his spurs in Delhis Yojana Bhavan before Delhi felt comfortable sending him back to Mumbai as governor! So central bank autonomy has not been such a hot issue in India as it has been either in Germany or, more recently, in Britain. But the financial media has always tried to discern differences and look for disagreements to see if the professionally more independent RBI took a different view from the more politically correct ministry of finance on the economy.

Reading governor Yaga Venugopal Reddys first review of the economy and enunciation of macroeconomic policy, it would be interesting to ask whether RBI is singing a different tune compared to North Block. On the big picture there are no basic differences, but it is interesting that the Union governments chief economic advisor Ashok Lahiri felt compelled to go public with the view that RBI was being a bit conservative on its growth estimate for 2003-04 of 6.5 per cent to 7 per cent

Only a fortnight ago Dr Lahiri had waxed eloquent on the possibility of the economy still meeting the Tenth Plan growth target of 8 per cent and was confident that this year growth would exceed 7 per cent. So how can the RBI offer a range between 6.5 per cent to 7 per cent The general public will dismiss such hair splitting on half a percentage point difference, but purists would like to know why there is this subtle difference between Delhi and Mumbai. Statisticians may conclude that it has something to do with data revisions, political economists may think it has more to do with making the voter feel good!

Journalists, however, will take note of the fact that on the day after the governor made public his views on the economy, he followed it up with a more optimistic growth projection stating that with improved export growth and better global economic performance, India could register upwards of 7 per cent growth. Macroeconomic purists have complimented the RBI for its conservatism on growth because it is better for the central bank to err on the side of caution than exuberance.

Given the exuberance in New Delhi about the feel-good factor in the economy, it is understandable that Delhi may well have liked RBI giving its more credible imprimatur to its more optimistic projections on election eve! But Mumbai has this habit of cocking a snook at Delhi every now and then!

Apart from the nuance on the growth numbers, the central bank has also flagged its concern on inflation. The mid-term review has been quite categorical. While stating for the record that the probability of emergence of any undue pressure on prices during this year appears to be low on current indications, the RBI goes on to warn, The Reserve Bank would continue to closely monitor the price behaviour leaving no room for complacency on the inflation front.

On an annual average basis, the central bank points out, the wholesale price index has registered an inflation rate of 4.9 per cent as on October 18, 2003, as against 2.3 per cent a year ago. Niall Booker, country head of HSBC India, was among the few in the banking sector who, perhaps thanks to a Bank of England orientation, took note of the RBIs warning on inflation and told The Financial Express, Governor Reddys first credit policy clearly indicates RBIs intention to move towards inflation targeting.

In the last few years, governor Bimal Jalans primary concern was growth augmentation and financial market stability. He had episodic entanglements with the exchange rate, but was not unduly perturbed by inflation since it was either generally subdued or, when it raised its head, it was related to discrete jumps in commodity, mostly energy, prices. For the first time in several months, the central bank may be beginning to get concerned about a more generalised price push, that can easily be fuelled by a liquidity overhang in the system. This would explain, in part, the caution on cash reserve ratio (CRR) and rates.

Policymakers in Delhi should also understand that all the exuberance about the feel-good feeling can evaporate in the heat of rising inflation. Growth is an intangible, prices are palpable. Since the government does not put out any employment data, the feel-good about growth does not easily translate itself to household sentiment. What matters more in India is the inflation rate. Rising forex reserves, an appreciating rupee, a rising Sensex and such like mean nothing to most in the face of a rising rate of inflation.

So rather than cavil about growth projections, Delhi must heed the worries about inflation. Many analysts still compare todays inflation rates with the highs of the past and see no problem in a 5 per cent rate when it is double-digit that one should worry about. The world has changed and India cannot afford even 5 per cent when world inflation rates are way below and the rupee is appreciating! But domestic tolerance for inflation too may have come down.

Normally, it is Delhi that worries more about inflation than Mumbai. But this time Delhi must thank Mumbai, that is governor Reddy, for the early warning. If inflation is kept under check, the feel-good feeling would be better sustained.