Interest rate tussle good for everybody

In the cacophony of allegations and counter-allegations and mock wars between political rivals trading friendly and unfriendly fire, the one meaningful tussle between finance minister P Chidambaram and Reserve Bank of India (RBI) governor Duvvuri Subbarao was smothered. Both would prefer not to describe it as a tussle, but evidence that each was doing his job. Chidambaram has, however, made it clear that he would have liked the RBI to reduce interest rates and help the government kick-start the economy. Hence his melancholic expression of “walking alone” the path of growth in response to the RBI’s decision to keep interest rates unchanged. Subbarao defended his decision and talked about concerns over inflation. He did not make this out to be a confrontation between the finance ministry and the RBI.

This establishes two things. First, the RBI has shown that the role of the central bank is not to be a pro-active player in the economy but a more conservative one of calibrating money flow in the economy and protecting it from going into a spiral of inflation. This defines the RBI’s role as that of a benign and independent gatekeeper. There was a time when the RBI was the handmaiden of the finance ministry; it responded to the expenditure of the central and state governments and printed the money the government needed. Of course, that did not solve the government’s problems. When money is printed to suit one’s needs, it loses its value. With the onset of economic reforms, it became necessary that the RBI was not seen as the government’s bank, and that it would ensure a level playing field for all money changers.

Of course, the RBI does not always maintain an Olympian distance from the economy. It often buys up dollars from the market to shore up a falling rupee. But this time, Subbarao said the bank would not interfere in the currency market and that the rupee had to fend for itself.

The economists in the government, not just Chidambaram, have not been very happy with the RBI’s interest rate policy since the economic crisis set in 2008. The 2012-13 Economic Survey indirectly referred to the RBI’s policy of keeping interest rates high as a dampener on the prospects of growth. The RBI was seen as unimaginative and not doing enough to push the economy forward. It is, however, good that there is someone at the RBI who is not ready to do the government’s bidding.

What ensures the stability of the Indian economy is this much vaunted institutional framework. Perhaps, the RBI should be a little more pro-active. If there had been a RBI governor without the same understanding and temperament as Subbarao, he would have coordinated with the government in putting the economy back on track. In withstanding government pressure, Subbarao has affirmed the rules of the system: the RBI is not part of the government.

There will be temptation to cite the example of the United States’ central banker, the Federal Reserve. The earlier Fed chairman Alan Greenspan, the Rand acolyte and the cool banker, seemed to have failed to arrest the crisis that precipitated in 2007 when he was at the helm. His successor, Ben Bernanke, is not flamboyant by Greenspan standards, but he did coordinate with the Bush Treasury department when the crisis broke out and worked out bailout packages for failing investment banks. Due to historical reasons, the RBI is modelled on the Bank of England, and it is not an active player in the economy.

Chidambaram and Subbarao are poles apart in their functions as parts of the engine of the Indian economy. In a recession, the government has to do all it can to revive the economy, even in a free market system. And Chidambaram is struggling. Free market ideologues would like to argue that in the present moment, it is the government which is the problem. The ideological venom being spewed is exciting, but the truth is that without government prodding through policy and expenditure, the private sector would not move because it wants incentives and concessions to invest and spend. The government cannot hope to abandon its welfare measures. Subbarao may sympathise with the government’s compulsions to keep subsidies going, but he cannot do much about it.

But one should be glad that Subbarao is holding fort. The tension between the finance ministry and RBI is good for everybody. It would be dangerous if RBI did whatever the government asked of it.

Parsa Venkateshwar Rao Jr is editorial consultant with DNA