Why RBI should continue fighting inflation under new govt

A fortnight ago, two big developments took place. The new BJP-led government under Prime Minister Narendra Modi took charge at the Centre and the GDP in the fourth quarter (Jan-March) of 2013/14 plunged to yet another low of 4.6 per cent.

GDP growth now stands at 4.7 per cent for the entire fiscal year 2013/14, which is a tad above  the 4.5 per cent  achieved in 2012/13. Thus this is the second year in a row that the GDP growth has been below five per cent, which actually calls for urgent action on the interest rates' front to spur growth.  

The previous Congress-led UPA government had differed with the RBI on many occasions on growth-inflation dynamics , but it never crossed its limits to impose its views on the RBI.

Will the BJP-led Narendra Modi government be any different ?

There are actually no differences between North Block and the RBI on supporting growth. One of the mandates of the RBI is to support growth and employment, the other two being inflation control and financial stability in the (banking) system. The RBI takes its mandate of price stability very seriously as it believes that a low and stable inflation rate is a prerequisite for achieving sustainable long term growth in the economy. 

Over the past many years, inflation has been averaging over 10 per cent. Consumer Price Index inflation ended at 8.59 per cent in April this year. One of the big contributors to inflation today has been the spiralling food prices. Governor Rajan has set a target for the RBI to bring down the CPI down to eight per cent by January 2015, i.e. within just six to seven months and six per cent by January 2016.

In view of the high inflation rate, the RBI Governor, who met Narendra Modi as well as Finance Minister Arun Jaitley during the past week, is expected to keep the benchmark interest rates unchanged at eight per cent.

Rajan will also look out for new government's initiatives on the supply side , especially increasing food production , improving productivity and efficiency  and cutting down wastages. In addition , the first Union Budget 2014-15 of the new government will be tabled in parliament  next month , which would also provide a peek into government's resolve to cut fiscal deficit and also subsidies.
 
As any economist would tell you that a sustained higher inflation has  negative implications for the domestic currency. As the money supply increases, the prices of goods rises substantially. This makes exports uncompetitive, while at the same time encourages cheaper imports into the country. This imbalance puts pressure on the currency. So Rajan's worry is also on the trade deficit or the current account deficit side, if the inflation persists for long.
 
Last but not the least, sustained high inflation eats into the savings of households, which impacts savings and investments in the long run.

Governor Rajan must have convinced the new regime over the last fortnight on  the longer term implications of inflation on growth, savings and currency. And the new government like the previous one will surely respect the RBI's tradition of integrity, independence and professionalism.