RBI says improvement in governance necessary to prop up the economy

In a major embarrassment for the Manmohan Singh government, the Reserve Bank of India (RBI) on Thursday pointed out that better governance and removal of supply-side bottlenecks in the infrastructure sector would be required for economic recovery.

This is probably the first time that an RBI governor has chosen to tick off the government on governance deficit.

"Growth continued to slow down in 2012-13, but could witness a slow-paced recovery later this year contingent on improved governance and concerted action to resolve structural bottlenecks especially in the infrastructure sector," RBI's latest report on the economy states.

Domestic policy uncertainties, governance concerns, the impact of earlier monetary tightening and the slacking of external demand continue to adversely impact growth, the report adds.

Industrial growth is now virtually facing stagnation resulting from a combination of factors, including supply-side bottlenecks and governance problems, according to the report.

While economists and industrialists alike have pointed out that the policy paralysis has added to the economic uncertainty and pulled down the growth rate, this is the first time that RBI has come out so strongly on poor governance and the policy drift.

RBI Governor D Subbarao is known for pursuing a hawkish monetary policy to control inflation and has ignored finance minister P Chidambaram's views in the past to bring down the interest rate and infuse more liquidity into the economy to spur demand and boost growth.

However, the Macroeconomic and Monetary Developments Report, released a day ahead of the 2013-14 monetary policy review, clearly breaks new ground in calling a spade a spade.

Former RBI governor Bimal Jalan said: "Everyone knows that governance is a problem but I would not like to comment on the report as I have not seen it yet. However, the growth rate is an area of concern as the economy is not doing as well as it was a couple of years or even a year ago."

According to the RBI report, recovery at the current juncture will critically depend on supply-side action to remove a host of micro-constraints and structural bottlenecks that impede production and investment especially in growth-driving sectors such as road and power.

The coal scam, which has created problems in the mining sector and hit investment in power plants, is a governance-related issue that the report is apparently alluding to. It refers to the issue of illegal mining as well.

Chidamabaram has been highlighting the fact that the finance ministry has embarked on a path of fiscal consolidation which has reined in the fiscal deficit and this gives more space for RBI to lower interest rates.

However, the report states that significant macro-financial risks prevail from slow growth, high current account deficit and inflation above the threshold over which it becomes inimical to growth sustainability.

"Therefore, monetary policy would need to be calibrated recognising the very limited policy space available to ease further," it adds.

The report further added, that inflation is likely to be range-bound and stay around the current levels in this financial year as supply-side issues, along with recent price adjustments in fuel prices, will offset the recent gains.

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