Amid a raging debate over the need for a pause in interest rate hikes, C Rangarajan, renowned economist and former governor of the Reserve Bank of India (RBI), believes the central bank should first try and bring down retail inflation to 6% – the upper limit of its medium-term target – before altering the pace of its rate increases.
In an interview to FE, Rangarajan said: “Take action to bring (retail) inflation below 6% first, then take action to take it to 4% because the idea is, over the medium term, inflation should be brought down to 4%, and not stay at 6%.” “And therefore, the best way of dealing with the problem is to get inflation to the upper limit first; up to that point, some strong action may be required. After that, the pace of action and the momentum can be changed,” he added.
The RBI has raised the benchmark lending rate by 50 basis points in each of the last three occasions and increased the rate by a total of 190 basis points to 5.9% since May to tame price pressure. Retail inflation scaled a five-month peak of 7.41% in September, having breached the RBI’s medium-term goal of 2-6% for a ninth straight month.
Rangarajan, 90, has written a book, Forks In The Road: My Days at RBI and Beyond, capturing key events between 1982 and 2014, a period of immense economic significance. The book, dedicated to former Prime Minister Manmohan Singh, will hit the stand this month.
While the central bank doesn’t target a particular level of the rupee, Rangarajan said, “the point really is we can’t, for that reason, let the rupee go wherever it goes”. “Then the terms of trade will turn against us. We should really act in order to be able to contain any sharp depreciation of the rupee,” he said.
“The point is that we should let the rupee find its own level, but we should also act to contain it once it goes beyond a level that’s not comfortable,” he added.
Raising the interest rate at this juncture, Rangarajan suggested, is necessary not just to help curb inflation but also prevent a steep slide in the rupee against the dollar, given that the US Federal Reserve has resorted to aggressive tightening.
“In one sense, what we need to do to control inflation and what we need to do to prevent the rupee from falling too much is the same—which is to raise the interest rate,” he said.
In the September review, two of the six monetary policy committee (MPC) members argued for a pause in rate hike. While Jayant Varma held that further rate hikes may derail a nascent growth recovery, Ashima Goyal felt the MPC should wait and watch to gauge whether the policy action so far is sufficient or not.
Meanwhile, the rupee has weakened by over 10% against the dollar in 2022, although it has still performed better than the currencies of many of India’s peers.
“The question of when to pause (the hike in interest rates) will depend on circumstances. If key economies raise their interest rates at a rapid pace, and the US is already doing it very clearly, then it’s very difficult to rein in the rupee decline at a moderate level. The choice is very limited,” the veteran economist said.
As the government prepares to firm up proposals for the next Budget, Rangarajan pitched for credible fiscal consolidation while facilitating economic growth. He also wanted the Centre’s push for Budgetary capex to continue, given its high multiplier effect.
“Now that the need for a lockdown or the restriction on mobility is no longer there, the role of the government should be such that it facilitates growth. But at the same time, the measures shouldn’t result in extraordinary increase in liquidity,” he said.
“As we go ahead, the need to bring down the fiscal deficit from the current level is equally important. So, some balancing act will have to be done by the fiscal authority,” he added. The Centre aims to reduce fiscal deficit to 4.5% of GDP by FY26. It hopes to contain the deficit at the Budgeted goal of 6.4% this fiscal.
Rangarajan’s latest book dwells upon the crucial role he played, as part of a team, to usher in liberalisation in the early 1990s, in addition to other events. During his tenure at the RBI, he was instrumental in introducing critical reforms, such as the deregulation of interest rates, gradual tightening of prudential norms to bolster the banking system, shift to the market-determined exchange rate and the cessation of the automatic monetisation of budget deficit. He served as the central bank’s deputy governor from 1982 to 1991, and its governor from 1992 to 1997.