The Governor’s Last Hurrah

August 2nd, 2011
in Op Ed

Subbarao by Sunil Chandra

Finally, he could not resist the temptation and decided to go out with a bang. Reserve Bank of India Governor D. Subbarao (pictured), whose current tenure comes to an end on 05 September 2011, must have been a worried man in the run-up to the monetary policy review on 26 July 2011.  Despite ten successive hikes in key policy rates, spread over 18 months, the Wholesale Price Index (WPI) continued to hover above 9% p.a.  His best monetary efforts to control prices had come to a naught. Therefore, he did a repeat of the May policy action of a double whammy and increased repo rates by a stupendous half percent.

Follow up:

Analysts astonished by hefty rate hike

In May 2011, the Governor had gone against wishes of the majority of his team of advisors when he decided upon the steep increase as the group was collectively in favour of a smaller hike only. He appeared to have calmed down in the June review when the rates were increased by the normal 0.25%. But last week’s action by RBI stunned the markets as senior bankers had actually advised the central bank to take a pause and give a respite to the increasingly fragile economy. Although, even while advising caution, they were reconciled to the normal RBI action of a 25 bps increase, they did not foresee the tough stance that was finally revealed by the central bank.    

As clueless analysts seek an explanation to this seemingly bizarre action, they appear to have forgotten a very simple fact. With only a small chance of an extension in tenure, the Governor may have acted somewhat hastily in an attempt to refurbish his institution’s sagging image. Perhaps, he considers the lack of success in taming the inflation scourge as a personal failure and, hence, the wish to make amends before he lays down office. If things work out as scheduled, the next Policy Review on 16 September would be the new Governor’s prerogative. Thus this action may well be described as the Last Hurrah of a rather disconsolate Governor.

Coming back to the Governor’s actions, we shall have to wait for a few years for the final judgment by history on his three year stint. However, Dr Subbarao undoubtedly deserves all the accolades he received, for steering India away from a monetary mess that was developing through the western world, when he took over in September 2008. In a series of bold yet measured steps, he ensured that there was no sad ending to India’s fledgling economic growth. It is only the second half of his stint, when the economy took a decisive turn for the positive, that his actions may not pass an in-depth scrutiny.

Was the Initial Meekness counter-productive

Consider this. From a negative inflation in July 2009, the WPI went up to 7.1.% by December 2009; further to 9.65% in February 2010, 10.88% in April 2010, 10.30% in June, 9.54% in February 2011, 9.74% in April 2011 and , lately to 9.44% in June 2011. Thus, there has been no let up in inflation over last 18 months. The question then arises as to why did not RBI take sterner steps in 2009 and 2010 and focused on “baby steps” only. The argument that the central bank did not want the economic growth, coming out of the 2008 stupor, to suffer does not pass examination.

It was quite clear by the beginning of 2010 that India had ridden out the crisis quite comfortably. Repo rates were ruling at the extreme low levels introduced in 2008. Therefore, was that not the correct time for the harsher steps. And even later, why only the baby steps of a quarter per cent each were announced? Why not a single increase of 100 bps to send a clear message to all that price control was a top priority?  The central bank could not have failed to notice that the initial baby steps were accepted quite merrily with little or no effect on economic activity. Well, the desired message was not delivered at that that time. Therefore, our next question- if not then, why now ?  

Is  High Inflation supporting High Growth

With rising fuel prices and high interest costs already acting as a deterrent to economic activity, the latest RBI action can only harm the growth prospects of a nation emerging from long years of poverty and deprivation. And all this with no guarantee of price stability in the process!  Moreover, one significant fact appears to have been overlooked by policy makers. The Indian economy appeared to be absorbing the impact of high inflation and the same was not harming growth. The poor and the middle class were also not really suffering as higher wages were compensating the increase in prices. Market forces were ensuring increased production of affected food items.  The latest food inflation of 7.35% (as against 18% last year) appears to support this hypothesis.

This brings us to our next grouse. In the early part of this century, the central bank found out that an inflation rate of 5.00-5.50% was acceptable and comfortable and conducive to economic growth. Has this issue been re-examined since then? Maybe, in the peculiar changed scenario wrought by the 2008 global crisis (and the consequent healthy respect for the Indian resilience), the new comfortable rate could be 9.00% or whereabouts. After all, higher GDP growth rates of 9% to 10% have never ever been witnessed before. Who is to say that such growth will not be accompanied by higher inflation?           

Now, with industrial production over the last four months continuing to show sharply declined growth rates, the ill effects on the larger service sector cannot be far behind. We do hope (and pray) that the Governor’s last hurrah does not come back to haunt the central bank in the near future. Amen.

Related Articles

Previous articles by Sunil Chandra

Deciphering and Solving the Inflation Crisis by Ajay Shah

About the Author

z Sunil_Chandra Sunil Chandra is CEO of an investment banking start-up, located in New Delhi. He was formerly associated with Punjab National Bank, one of India’s largest, and, later, as Country Head for some leading bond houses in India.  He has earlier written for Hindustan Times and other publications.

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