Dec 12, 2024 07:15 IST
First published on: Dec 12, 2024 at 07:15 IST
-
Share
Recent statements made independently by the commerce and finance ministers have amounted to advising the Reserve Bank of India (RBI) on how to conduct its monetary policy. The crux of what they had in mind has to do with the rate of interest being too high, though it was not communicated so directly. While we cannot be certain of what prompted the ministers’ statements, speculation is that the government is concerned that growth may be slipping, reflected in lowering quarterly growth rates observed since April. If this is so, it reflects an extreme short termism. After all, the economy notched up a GDP growth rate of 8.2 per cent in 2023-24. That is a historic high. Moreover, should a government be only concerned about growth, throwing all concern about its distribution out of the window? But this is a larger question, and less relevant in the context. What is relevant in the context is whether the government should interfere in the functioning of the RBI and whether the RBI can make a significant difference to the growth of the economy today.
On whether the government should interfere in the functioning of the RBI, even to the extent of exhorting it to undertake certain actions, the answer would be a resounding “no”. India’s central bank is governed by its board, which the government has had a say in choosing, after which it should let them take things forward independently. This would be in the spirit of the separation of powers between the executive and India’s public institutions. In the context of the RBI’s conduct of monetary policy in particular, the current arrangement gives the RBI a certain autonomy. To be precise, since 2016, the RBI is mandated to mainly control inflation, and a target inflation rate of 4 per cent has been set by the government. Once this has been agreed to, the RBI should be allowed to vary the interest rate as it sees fit. It is not appropriate that the government makes public recommendations to the bank, undermining its credibility as an independent actor. The Commerce Minister has proposed that food-price inflation, which currently is very high, be taken out from the inflation target and the Finance Minister has expressed concern that credit may not be sufficiently made available. Both observations are aimed at persuading the RBI to lower the rate of interest.
The answer to whether the RBI can do something about the growth of the Indian economy in the present conjuncture is also very clear, though it would require some reflection to get the full picture. Presumably, it is the growth of the manufacturing sector that is the source of the worry. Real GDP has been estimated to have grown by 6 per cent in the first half of 2024-25, having grown at 8.2 per cent in the first half of 2023-24. Manufacturing growth over the same periods has been 9.6 per cent and 4.5 per cent, respectively. Though a detached observer would not be particularly moved by performance recorded over such short periods, it is conceivable that it is galling to a government that has devoted much of its policy attention for over a decade to manufacturing. However, it is likely to be disappointed if it believes that the RBI can do much about growth in the economy presently.
In the past two years, growth has been driven by a scorching increase in public investment by the central government. This has made up for tardy private investment. But it may not have been able to counteract the slow growth of consumption. While national income data do not show any decline at all in the growth of private consumption in the first half of the current financial year, the leading corporates of the consumer-goods sector speak of slow growth of sales. This suggests that demand is not growing fast enough. It is not surprising for we have witnessed a decline in real wages continuously for close to six years by now. If what the economy is experiencing in the medium term is actually a slow growth of demand, then a reduction in the interest rate is not going to help even if the RBI will heed the pressure from the government. Firms expand production in response to expanding sales, and are unlikely to borrow more solely because the rate of interest is lower if their anticipation of sales remains unchanged. By pressurising the RBI to lower the rate of interest, the government is proposing a supply-side solution to a demand-side problem.
In all of this, the Commerce Minister’s proposal, earlier made by the Chief Economic Advisor, that food inflation be taken out of the official index of inflation, is a solution for neither growth nor inflation. If food inflation is not curbed it can affect the growth of the non-agricultural sector, especially of manufacturing, by crimping consumer budgets as households must first meet their expenses on food before anything else. Second, to have the price of food taken out of the official inflation index without proposing a policy for controlling food inflation, which exceeded 10 per cent in the month of October, is tantamount to just giving up on inflation control.
The comments by cabinet ministers responsible for the economy reveal a certain nervousness on the part of the government about growth. They amount to exhorting the RBI to prioritise growth over inflation control. Apart from the propriety of these interventions, it is not clear that a reduction of the interest rate will do much for growth when the market is not growing fast enough. A central bank cannot grow the market.
The writer is honorary visiting professor, Centre for Development Studies, Thiruvananthapuram
