Time to pass the baton to Delhi

Written by Shubhada Rao | Shubhada Rao | Updated: Apr 2 2014, 09:06am hrs
FY14 was a year of two halves. The first marked by accelerating external sector stress, policy logjams widening the domestic macro imbalances, weaker currency, sticky inflation, and a depressed investment outlook. The onus was largely borne by the monetary policy prompting the RBI to maintain a hawkish policy stance despite decelerating growth momentum.

There were, of course, some measures taken by the government to declog investment bottlenecks, to trigger a modest recovery in investment. The second half was, thus, marked by a period of corrective actions to address the macroeconomic imbalances, thereby imparting the much-needed stability towards the end of the fiscal year. The challenges that, however, remain are of reviving growth and bringing down inflation to a level consistent with sustainable growth momentum in the longer run.

Going into FY15, while CPI inflation is broadly expected to follow the RBIs projected glide path towards 8% by January 2015, upside risks from poor monsoon, commodity price shock and fiscal policy uncertainty remain.

As articulated by governor Raghuram Rajan, monetary policy will continue to remain vigilant to fight inflation. However, in my opinion, the interest rate channel alone cannot mitigate the adverse spillovers from these event risks. In the current weak growth environment, fiscal policy needs to play a larger and a proactive role. In this context, prudent revision in MSPs, allowing calibrated fuel price adjustments and formulating a responsible budget with an equal emphasis on quality of fiscal adjustment will play a critical role in shaping the inflation outlook.

These structural measures will not only help in mitigating inflation risks in FY15, they will also enable in the transition of CPI inflation target from the current level of 8% to 6% by end of January 2016, in sync with the Urjit Patel Committee recommendations.

Formation of a strong coalition government is a prerequisite for a facilitating environment. As the new government takes over, measures to boost productivity of capital through faster project clearances, creating an investment friendly environment through reforms and improving long-term fiscal health by introducing GST and DTC will pave way for improving the growth potential for the economy, which, in recent years has deteriorated sharply.

In a similar vein, administrative measures to correct structural inflation by dismantling supply side constraints, efficient food distribution, reviewing the APMC Act, etc., would play a critical role in managing the unexpected surge in food prices and keeping expectations anchored.

However, a failure on part of the government to improve the growth-inflation outlook may complicate the task of monetary policy yet again. Persistent weakness in the manufacturing sector and weakening momentum of investment cycle suggests that a lot more to needs to be done.

With a battle half-won against inflation, we expect fiscal policy to play a more active role going forward. A dominant role played by the fiscal policy will enable the RBI to focus on its five pillars of reform agenda, thus addressing the long-term structural need of liberalisation of financial markets.

The writer is senior president & chief economist, Yes Bank