It is customary in the global financial practice to give the federal reserve of a country complete freedom to fix the basic interest rate (discount rate) and any intervention by the government in power to disrupt this practice is completely abhorred, not the case in India. Yesterday, Dr. Raghuram Rajan the governor of RBI took a bold step to tell the government of India to cease asking banks to lower rates. He said and I quote “The government should eschew moral suasion and directives to banks on interest rates that run counter to monetary policy actions”. The monetary policy committee (MPC) that went into the details of the current economic performance of the country came up with the following recommendations.
(a) RBI should target inflation at or below 4 percent after achieving 6% CPI target in 2 years
(b) The rate must be decided by the MPC committee headed by RBI officials and external members
(c) MPC should meet once in 2 months
(d) They must acknowledge failure to curb inflation and give reasons
(e) The government must discontinue administered setting of prices, wages and interest rates
(f) The government should stop giving directives to banks on interest rates
(g) Fiscal deficit must be brought down to 3% by 2016-17
(h) Interest rate subvention on farm loan must be discontinued
The mission of the MPC committee is to target the inflation rate measured by CPI to 4 percent per annum. In the past Indian finance ministers have always intervened in the functions of RBI for obvious political reasons. The parliament should consider that inflation targeting as the primary consideration in all decision making. Given the present set of practice, it is only a matter of time that our bond ratings will be scaled down to a junk status. The question on the minds of Indian citizen is why deposit money in the bank when the rates of interest offered for deposits fall far short of the inflation rate. Don’t blame them if they convert their savings to land holdings and gold. All good money will leave the bank and the government will realize the need for realigning the interest rates to attract deposit and to encourage the flow of funds. Anyway, the current practice of the government intervention in RBI activities will change eventually but sooner the better.