Unusual candour was on display from a central banker last week when Duvvuri Subbarao said in a speech, “The jury is still out on the issue of fiscal dominance of monetary policy. But it will be less than honest not to acknowledge that the autonomy of monetary policy from fiscal compulsions is once again under threat, and resolving that threat requires credible efforts by both governments and Central Banks.” For the Oracles of Mint Road, given to couching their utterances in Delphic vagueness, this is plainspeak. The provocation, it can be argued, has been sufficient: the finance ministry is moving legislation that will strip the central bank of its primus inter pares status among India’s financial policemen, and a government obsessed with rapid growth is seen as curbing the Reserve Bank’s (RBI’s) zeal to rein in runaway inflation by raising interest rates faster.
As it is, the many hats the RBI is made to wear affect its ability to carve out independent monetary policy. Besides being the monetary authority, the Central Bank triples up as the banking regulator and the government’s banker as well. The conflict of interest in these roles has led to the trifurcation of the traditional Central Bank in mature capitalist systems. We persist with one institution, netting sub-optimal solutions. Changes in interest rates crimp the government’s enormous borrowing programme, and do not work their way through the structural rigidities of our banking system. Now, with the finance ministry taking upon itself the role of arbiter in any turf war between financial regulators, the RBI’s commendable record in flagging systemic risk — it did protect India from many of the credit market excesses in the West — will have been given a go-by.
At the best of times, the RBI’s targeting of the price line runs up against a troika of opposing interests: managing the exchange and interest rates with an open capital account. Add to these the development imperatives and the proclivity of the Indian economy to supply-side shocks, and the received wisdom of the central bank’s main job as inflation buster takes a knocking. Prices rise in India primarily because of our insecurities in food and energy. Our central bankers are extremely sensitive to both, but have to restrict themselves to warning the larger policy establishment till such time as accelerating prices enter core inflation — minus the more volatile food and fuel. By the time it can push the policy levers, much damage has been done as is on display after last year’s drought. Mr Subbarao ought to get a more sympathetic ear from a government headed by a former central banker.