During the Reserve Bank of India’s press conference last week, one exchange stood out. Asked about a meeting scheduled by the federal Ministry of Finance in New Delhi to discuss the RBI’s policy, the governor of India’s central bank, Urjit Patel, replied: “The meeting did not take place. All the MPC members declined the request of the finance ministry for that meeting.” The MPC is the Monetary Policy Committee, a six-member council that sets India’s benchmark interest rates. It’s a new institution, less than a year old; Patel’s predecessor, Raghuram Rajan, had full authority to set interest rates himself. But it seems India’s government is not as comfortable as many had hoped with this new arrangement — summoning the MPC members to the finance ministry before they decided rates was widely seen as an attempt to interfere in their decision. So it’s a great relief that the RBI stood firm. Its independence has been questioned of late, partly because of the circumstances in which Rajan left, under pressure from lawmakers in New Delhi, and partly because of its supine acceptance of the government’s controversial decision in November to withdraw 86 percent of India’s currency from circulation. The government should never have asked for the meeting; but, given that it did, the members of the MPC were right to refuse.
In any case, they knew what the government was likely to say: “Please, for the love of God, cut rates.” India is confronting a growth slowdown that is born, most agree, out of a sustained crisis in private investment. It doesn’t take a meeting with the government for the MPC to know that. Yet it has ignored the pleas of officials — and of many in the private sector — and kept rates steady. This determination emerges from another relatively recent reform: an agreement between the central bank and the government to shift to targeting consumer price inflation. A clear goal for the RBI — rather than a vague admonition that it should care about growth, prices and the exchange rate all at once — adds to its independence and clarifies its approach to monetary policy. But the government has grown increasingly frustrated. After all, not only is growth slowing, but the RBI has refused to reduce interest rates even as the inflation rate has fallen to historic lows.
Some argue that the MPC is simply ignoring or misreading the evidence. Even the RBI had to admit that its inflation forecast for the first quarter was off by an unusually large 1.4 percentage points. But it’s not as if the RBI has completely ignored inflation dynamics: It revised its forecast for consumer price inflation sharply downward for the six months from April to September, from 4.5 percent to between 2 percent and 3.5 percent. That’s well below its target rate of 4 percent.
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So why didn’t it cut rates? Two reasons. First, because this decrease in the inflation rate is probably one of the after-effects of the cash shortage. That caused prices for agricultural goods, especially the food staples that dominate India’s consumer price index, to crash. The RBI worries that these effects are transient — which is, of course, the government’s own view about the negative effects of “demonetization,” as it’s called. And second, because the RBI feels the government isn’t doing its job. Its statement last week was unusually blunt: “The current state of the economy underscores the need to revive private investment, restore banking sector health and remove infrastructural bottlenecks. Monetary policy can play a more effective role only when these factors are in place. Premature action at this stage risks disruptive policy reversals later and the loss of credibility.”
In other words, the RBI simply doesn’t trust the government to take the measures needed to end India’s investment crisis. The members of the MPC clearly feel that reviving investment is the government’s job, not theirs.
Frankly, they aren’t wrong. The government should never have summoned the RBI’s decision-makers, because it looked like interference. But even more than that, the government needs to accept that a deus ex machina won’t be saving India when it comes to growth. The central bank isn’t going to swoop in from Mumbai and make things right. Its remit is inflation. The government’s problem is reform. Rather than asking for meetings with the Monetary Policy Committee, the finance ministry should be hammering on the doors of other ministries in New Delhi, asking why the pace of reform is so slow.
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