Subbarao hits back at RBI critics

He received enormous praise for the Reserve Bank's deft handling of the macro economy in the face of the financial meltdown triggered by the collapse of Wall Street firm Lehman Brothers and the eventual global economic downturn of 2008/09. But RBI Governor Duvvuri Subbarao is now being blamed for India's inflation problem. In an interview with Associate Editor Puja Mehra, soon after announcing the annual monetary policy on May 3, Subbarao rebutted his critics and said that, looking back, he would not have done anything differently. Edited excerpts:

Q.The Reserve Bank drastically revised its projections for inflation in March and yet the actual numbers came out a percentage point higher than the 8 per cent projection. Why couldn't the Reserve Bank project inflation accurately?
A. The actual numbers for inflation started deviating from our projections of forecast starting December 2010 onwards. In the period April to December, our forecasts were pretty much on track. A lot of known unknowns have come into play. For one, the international crude prices were a result of a number of supply and demand factors which could not have been foreseen. That there would be such recovery in advance economies, that there would be financialisation of commodities and the political developments in Africa and the Middle East.

Second, the way input prices translated into output prices because of demand pressures that were much stronger than we had thought. Third, there was the unseasonal rise in vegetable prices. The economists in RBI have told me that the non-food manufacturing inflation numbers for December 2010 to February 2011 they had under-reflected the demand pressures. Therefore, we went off-track in getting the March numbers. All that is not to say we need not improve our forecasting techniques. We should and I myself have seen in the last three years that our modeling techniques have got very sophisticated.

Q. Business Today has just constructed a Business Confidence Index , the first survey for which was concluded in early March and our main finding that companies are enjoying significant pricing power owing to robust demand just as the annual monetary policy statement notes. Business it would seem therefore loves inflation....
A. They might have loved inflation as input prices were high and without sacrificing their margins they were able to pass on input price rises but that was clearly unsustainable. They could not maintain that for long. It was not in the interest of long-term profitability.

Because it comes back to haunt them as wage cost inflation pressures? That's right.

Q. So were demand pressures high due to monetary policy and fiscal policy being looser than desirable or loose for longer than desirable?
A. Monetary policy wasn't loose. If you look at M3 [Measure for money in circulation in an economy which if high can fuel inflation as too much money would be chasing a supply of goods services that can not be expanded in the immediate term] it was 15.9 per cent certainly below our projection of 17 per cent. If you look at real policy rates which is another indicator some analysts throw at me depending on what on inflation rate you use for expected inflation you could arrive at positive or negative real rates.

But the important thing to remember is that where we are coming from. We had done extra-ordinary loosening during the crisis. Policy rates went to historically low levels. We needed time to bring them up and it needed to be done in baby-steps. So to say that monetary policy was loose beyond the appropriate time I think would be incorrect. You might recall that many analysts were saying that we should have loosened further. The same people now say that it was much too loose for much too long.

Q. So the fiscal situation now is going to be the real determiner now for aggregate demand and therefore inflation. Are you throwing the ball into the government's court as far as fighting inflation goes?
A. We are not throwing the ball into the government's court but it is just stating a matter of fact which is that government is a big player in the macro economy. The fiscal deficit can affect the aggregate demand. So we have said that it is one of the variables that affects demand and thereby affects inflation management.

Q. So demand pressures were high because not monetary policy but fiscal policy was too loose for too long?
A. I don't want to comment on that but certainly I would say that the fiscal stimulus that the government had done as anti-crisis management measure was certainly called for. Reversing that and reverting to our track of fiscal consolidation is also important imperative. The government has done that although there is some talk that the projections are short of the targets indicated by the Thirteenth Finance Commission. There are challenging circumstances. It is difficult both politically and macro-economically to bring the fiscal deficit down but it needs to be done. So I won't call the fiscal policy excessive or accommodative but I would certainly say that fiscal consolidation is an important imperative for our inflation management.

Q. Given the global oil price situation how confident are you of the government being in a position to achieve the targets for fuel and fertiliser subsidies and therefore the fiscal deficit that Finance Minister Pranab Mukherjee had set in Budget 2011?
A. The finance ministry had set the targets in end-February and the oil prices situation was different then from what it is today. Certainly there is doubt about whether those fiscal targets can be met under the current price scenario unless some adjustments are done to administered prices.

Q. You have very clearly stated in the annual policy statement that inflation is an evil, it hurts investments. Has the Reserve Bank finally said that inflation targeting is its dharma?
A. I don't think you should translate our comment in the policy as an endorsement for inflation targeting because inflation targeting means different things. But it is quite true that when inflation is as high as this in a country as poor as ours, controlling inflation becomes the top priority. Indeed even to have sustainable growth over the medium term we need low inflation so that we provide a predictable environment for investments.

Q. The industry is complaining about high interest rates. The lobby group Confederation of Indian Industry in particular has issued a statement saying the latest rate hike of 50 basis points will hurt growth. Would you like to reassure them? 
A. I can quite understand their concern. I sympathsise with that but what I want to tell them is that inflation hurts even investors by creating uncertainty for them. The endeavour for the Reserve Bank is to bring inflation down to create a more predictable and a more conducive environment for investments so that even if we sacrifice some growth now in the medium term we will have low inflation high growth. So sacrifice some now for more later.

Q. The exports situation has improved and therefore also the current account deficit. How comfortable does that make your life?
A. Exports have shown remarkable buoyancy and that is even more remarkable because it happened even as the exchange rate appreciated both in nominal and real terms. However, export demand will depend not only on our competitiveness but also external demand and how advanced economies will recover so that is very important for export performance.

Q. How much does the Index for Industrial Production, the rate of growth for which has remained below 5 per cent for three straight months, worry you?
A. IIP does concern me. IIP is one of the indicators we look at. It has come off lower. It has been a cause for concern and an analytical challenge because of the volatility. So IIP shows that industrial performance is not as buoyant as we would like it to be. But there are other indicators like we talked about: credit offtake, tax revenues of the government, some of the sales and earnings performance of companies. Those were not as bad as the IIP.

Q. On a relative basis are we better off than we were a few months ago?
A. I hope so. These are short-term challenges. We have high inflation. Therefore sacrifice growth. But I believe in the medium term all the drivers of growth are intact. In the medium term, we should be able to increase our growth rate in an environment of price and financial stability.

Q. Is there anything either the Reserve Bank could do differently for a better growth-inflation combination than the 8.6 per cent you've projected?
A. It is difficult to answer that question. We have no counterfactual to evaluate. I want to say that our policy action last year was driven by evolving inflation-growth scenario as it was today. I am not sure that I would have done anything differently.