“If on 46-70% of the basket I do not have much influence, how can I deliver on any inflation target,” asks Duvvuri Subbarao
It would be “inappropriate, unwise and incorrect” to limit the central bank’s role to just inflation targeting, Reserve Bank of India (RBI) governor Duvvuri Subbarao said in a retort at those working on a plan to create the Financial Stability and Development Council (FSDC), which would undermine its primacy among regulators.
While delivering a foundation-day lecture at the University of Hyderabad on the dilemmas of central banker on Monday, Subbarao said the challenges India faces today would not allow the RBI to focus just on inflation.
“There are arguments that we in India and the RBI in particular must become an inflation targeter. There are very persuasive arguments for that. The main one is that the RBI has a number of responsibilities and (therefore) its focus on inflation is diffused. On the other hand, (the argument goes) if given a single-point objective, you (the RBI) would deliver better on inflation,” Subbarao said.
However, he said, there are practical difficulties.
The Union Budget for this fiscal had mooted that the FSDC be set up to handle issues related to the country’s financial stability.
According to analysts, this implies the RBI would be confined to just handling inflation by controlling money supply.
Though not directly hitting out at the FSDC proposal, Subbarao said, “The argument also is that inflation is a much more critical variable in a poor country like India. We have hundreds of millions of people that are poor. Inflation is a very regressive tax and it hurts the poor the most.
“If the RBI is divested of its other responsibilities, it will deliver better on inflation therefore the RBI must become an inflation targeter. I disagree with that (notion) and the RBI has reservations against the argument of being an inflation targeter. The RBI has an objective for growth, financial stability and price stability. These are the core objectives and we (try to strike a) balance between them. In a poor country like India, it is not appropriate or indeed correct for the RBI to be focusing only on inflation,” Subbarao thundered.
While talking about five key dilemmas the central banker faces, he also cautioned about the outcome if the central bank is made an inflation targeter.
“Imagine if I am given an inflation target and no other target, I am going to raise rates regardless of anything else because I have to deliver on the target. That’s going to hurt a number of other things. You cannot, in an economy that’s at our stage of development and our concerns, features and characters, set an inflation target and expect the RBI to deliver that.”
Elaborating on why the RBI should not be asked to look at inflation alone, Rao said,
“Our inflation emanates from the supply side more often. If you look at the inflation basket with CPIs and WPI, food has 46-70% in the CPI basket. If on 46-70% of the basket I have not much influence, how can I deliver on inflation target? Which inflation target do we target? We have one wholesale price index and four consumer price indices. For a country with 1.2 billion people, fragmented markets and vast heterogeneity, can we have a single number representing Nagaland, Kerala and Orissa at the same time?”
“Monetary transmission is yet another point. When the RBI changes the rates or takes an action, it transmits to the economy through the banking system. Monetary transmission is a problem. Some rates, particularly the small savings rates, are still administered. We also have large government borrowings and illiquid bond markets. So monetary transmission will not work effectively. Unless we reach there, it is almost impossible to target inflation.”
When you have strong capital flows we have several objectives to simultaneously balance including the exchange rate, monetary policy and the interest rate.
“It is difficult to just focus on inflation. It is both inappropriate and I believe unwise for the RBI to target inflation.”
However, when asked to comment on the status of the FSDC, Subbarao refused to make any specific comment since “it is the government which would take it forward”.