Subbarao isn't an isolated hawk on inflation anymore

By R Jagannathan

Almost exactly a year ago, Duvvuri Subbarao was seen as the lone hawk on monetary policy. Today, thanks to the government's fiscal incompetence, the doves have metamorphosed into hawks on inflation.

According to the minutes of the Technical Advisory Committee (TAC) released by the Reserve Bank of India (RBI) yesterday, at the TAC meeting on 25 July (held a week before the monetary policy was announced), five of the seven external members said that the RBI should not cut the policy rate (repo rate, the rate at which the RBI lends short-term money to banks).

The minutes had this to say: "They (the TAC doves-turned-hawks) felt that given the fiscal dominance, double-digit consumer price inflation and no realistic expectation of credible action from the government, the Reserve Bank needs to focus on tempering inflation expectations." (italics ours)

And what of those two remaining doves? Even they were less dovish. "The remaining two of the seven external members suggested that there could be a symbolic reduction in the policy rate by 25 basis points to stimulate investment. One of them also suggested a reduction in the CRR by 25 basis points." (100 basis points make 1 percent)

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The doves wanted only a "symbolic" reduction, which Subbarao chose to give in the form of a one percent cut in the statutory liquidity ratio (SLR) instead of the CRR (cash reserve ratio). Since SLR is about banks investing in government bonds, letting them invest less means asking them to lend more to corporate India rather than Bharat Sarkar.

This hawkish tone is in sharp contrast with the TAC's predilections a year ago, when there were all-round calls for a reduction in rates but high inflation forced Subbarao to raise repo rates a second time by 50 basis points (0.5 percent) in July 2011. As we wrote then: "At the TAC meeting held on 20 July...four members were not in favour of any kind of rate hike, while one favoured a 25 basis points hike. Two others said if a rate hike was unavoidable, they would prefer a token hike of 25 basis points."

Clearly, the government's incompetence on the fiscal front - it has been dithering on diesel price hikes and cried off subsidy cuts anywhere - has convinced almost all the doves that if anyone has to fight inflation, it has to be the RBI.

The minutes of last month's TAC meeting make it clear that the ball and the blame are clearly in the government's court."The economy is in a bind with slackening growth and elevated inflation, but the remedies, members felt, lie with the government."

[caption id="attachment_426165" align="alignleft" width="380"] Subbarao had already gone out on a limb in April by cutting rates by 50 basis points when it was not warranted. Reuters[/caption]

After noting the potential impact of a deficient monsoon on inflation, the consensus was that the real price pressure would come in protein items like milk, pulses, eggs, and meat, among other food items. "Structural problems, such as those in protein items, are keeping non-core inflation high. Additionally, inflation concerns stem from suppressed inflation and tightening supply bottlenecks in infrastructure....On the fiscal front, many members apprehended that there could be a slippage in the fiscal deficit in 2012-13."

Clearly, TAC does not expect government to suddenly act responsibly.

A caveat is in order: the TAC is only an advisory group and the RBI Governor is not bound to listen to it. What is important here is that this advisory group has shifted its position from what it was advocating last year - when it was tilting towards growth - and moved closer to Subbarao's own assessment of the need to douse inflationary-expectations and giving it priority over growth.

From a position where the governor was more hawkish than TAC, both governor and TAC are now moving in tandem, with the government found wanting in anti-inflationary zeal.

It remains to be seen if this new consensus on inflation will impact the RBI's mid-quarter review of the monetary policy on 17 September.

Both the wholesale price index and the consumer price index have fallen in July, but all analysts agree that this is a mirage - a temporary blip caused by the high base effect of 2011.

The betting should be that Subbarao may not do anything more than symbolic monetary easing next month - if at all - despite Finance Minister P Chidambaram's announcement earlier this month that he would like to bring down interest rates.

He had said: "Interest rates inhibit the investor and are a burden on every class of borrowers. Sometimes, it is necessary to take carefully calibrated risks in order to stimulate investment and to ease the burden on consumers. We will take appropriate steps in this regard."

The TAC members and Subbarao may want to agree, but whether they will do anything about this or not depends on Chidambaram himself - and how he handles the fisc.

The problem is Subbarao had already gone out on a limb in April by cutting rates by 50 basis points when it was not warranted. He thought the finance minister (then Pranab Mukherjee) would deliver on his promises of fiscal probity. It didn't happen.

But should he take a promise for the real thing a second time?

As Rajeev Malik, Senior Economist at CLSA in Singapore, puts it: "The bigger-than-expected 50 bps rate cut in April was mainly on the expectation of some constructive government action on fiscal consolidation. Hopefully, the central bank won't again ignore the lessons from its institutional experiences of dealing with the government, and will wait for the ill-disciplined government to act rather than buying its promises."

Over to you, Mr Chidambaram.