RBI’s ‘trilemma’ on price control

  • Hindustan Times, New Delhi
  • Updated: Dec 03, 2014 11:09 IST

When Raghuram Rajan took charge as Reserve Bank of India (RBI) governor last year almost everyone — from bankers, entrepreneurs and executives to investors — hoped he will usher in a pro-growth shift in India’s monetary policy (Read: Lower interest rates spur investments and kick-start growth). Mr Rajan’s job comes with unenviable challenges and on his first day, he made it clear that he wasn’t aiming at accumulating ‘Likes’ on his Facebook page and that some actions may not be popular.

The primary duty of most central banks in the world is to influence the flow of money and credit. In the RBI’s case that comes with a few associate roles as well.

It has to have a monetary policy that keeps prices stable and ensures adequate funds to productive sectors. It is also a watchdog for banks. It prints money and prevents volatility in the foreign exchange market. Besides, it also has to act as the central and state governments’ banker and the lender of last resort.

So, when Mr Rajan kept the interest rates unchanged on Tuesday, he probably has a convincing argument that the battle against inflation isn’t over yet. His ‘pro-growth’ image had triggered hopes that he will quickly shift the balance towards growth in the classical price versus investment trade-off. As he kept interest rates high over the last 15 months, that opinion appeared to have reversed. In the customary post-policy media interaction, Mr Rajan said that low and stable inflation is one of the most necessary conditions for achieving sustainable growth. This is the precisely what the RBI is seeking to achieve.

Mr Rajan faces what economists call a central banker’s ‘trilemma’. He has to keep the rupee from sliding further, cool inflation and create conditions that will boost growth. Most central bankers have to deal with one or two of these challenges at a time. Attempting all three simultaneously is a Herculean task.

Central bankers aren’t prone to being swayed by forceful pleas. They are also not generally influenced by the QSQT syndrome: Quarter-se-quarter-tak. Instead, they always take a long- and medium-term view of economy. The decisions, arrived at after rigorous statistical analysis, are predicated upon past data and future expectations. If companies aren’t adding capacities, it may not necessarily be because of a high cost of capital.

It may also be because of low demand for their goods as the people aren’t spending enough. Likewise, probably in the RBI’s analysis, four months of falling inflation may not be a long enough trend to drop the guard on price control. Mr Rajan’s rather dogged commitment to bottling the inflation genie needs to be seen through this prism.

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