RBI can never abandon inflation to focus on growth: Rajan

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Old 21-Jun-2016
Post RBI can never abandon inflation to focus on growth: Rajan

Within days of announcing his decision to leave the RBI in September, Governor Raghuram Rajan on Monday hoped his successor and the new Monetary Policy Committee will “stay the course” to ensure a low-inflation future for the country.

“In the days ahead, a new Governor as well as members of the Monetary Policy Committee (MPC) will be picked. I am sure they will internalise the frameworks and institutions that have been set up, and should produce a low-inflation future for us,” Rajan said.

The government has taken the “momentous step” of both setting a consumer price index-based inflation objective for the Reserve Bank as well as setting up an independent MPC, he said.

Rajan on Saturday said would not accept a second term of governorship.

While delivering the foundation day lecture on ‘Fight against inflation: A measure of our institutional development’ at the Tata Institute of Fundamental Research here, Rajan called for institutionalising the yet-to-be constituted MPC, so that “we build the institutions necessary to secure a low inflation future, especially because we seem to be making headway.”

Describing the MPC as a truly revolutionary step, he said we got used to decades of moderate to high inflation, leading to industrialists and governments paying negative real interest rates and the burden of the hidden inflation tax falling on the middle class saver and the poor.

“With the MPC, which is truly revolutionary, we are abandoning the ways of the past that benefited the few at the expense of the many. As we move towards embedding institutions that result in sustained low inflation and positive real interest rates, this requires all constituencies to make adjustments” he said.

Warning that a move to a sustained low-inflationary regime demands a lot difficult and painful adjustment in the short run, he said the rewards, however, are be many such as cheaper money for individuals and corporations as well as for the government.

Noting that the past three years of inflation fighting has created a stable macro-environment, Rajan, who took over when the rupee was falling like nine pins and balance of payments was on a precarious position, said a “stable rupee has given investors confidence in our monetary policy goals, and this stability will only improve as we meet our inflation goals.”

Urging the government and the new governor to stay the course, Rajan said going forward, the present stability “will ensure that foreign capital inflows will be more reliable and increase in the longer maturity buckets, including in rupee investments, which will expand the pool of capital available for our banks and corporations. “

Listing the long-term benefits of a low-inflationary economy, the governor, who will demit office at the end of his three-year tenure on September 4, said a stable rupee can increase investors’ confidence in our monetary policy goals; foreign capital inflows will be more reliable and increase in the longer maturity buckets, including in rupee investments.

“This will expand the pool of capital available for our banks and corporations. The government will be able to borrow at low rates, and will be able to extend the maturity of its debt. The poor will not suffer disproportionately due to bouts of sharp inflation, and the middle class will not see its savings eroded,” Rajan said.

Rajan, however, was quick to add that for all this to happen and if the money were to indeed become cheaper, “industrialists will have to support efforts to improve loan recovery so that banks and bond markets feel comfortable with low credit spreads”.

“The Central and state governments have to continue on the path of fiscal consolidation so that they borrow less and thus spend less on interest payments; households will have to adjust to lower nominal rates, but must recognise that higher real rates make their savings more productive and they will find it worthwhile to save more to finance the enormous investment needs of the country,” he said.

On the MPC, Rajan said an inflation-focused monetary policy framework means “better coordination between the government and the central bank as they go towards the common goal of macro stability. Further, the central bank can serve the economy and the cause of growth best by keeping inflation low and stable around the target given by the government.”

Stating that there is no long-term trade-off between growth and inflation, he said the best way for a central bank to ensure sustainable growth is to keep demand close to supply so that inflation remains moderate, and the other factors that drive growth, such as good governance, can take centre stage.

“We can never abandon inflation to focus on growth”, Rajan said, adding “the best way the monetary authority can support growth over the medium-term is to anchor inflation at low levels so that policy rates can also be low.”

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