Election and RBI

Dr. Subramaniam Swamy, a well-known politician made a statement to the press a few days back stating that Dr. Raghuram Rajan should quit as the RBI governor. He said that Dr. Rajan’s economic policies are not suited to the Indian economy. Basically he said that interest rate should not be used as a tool to fight inflation and the investors in the bank should be rewarded a much higher rate of return as the current interest rates on deposits are not adequate to cover the inflation.

Traditional literature in economics suggests that whenever inflation rate is getting higher beyond the acceptable level the monetary authorities use the interest rate mechanism to control it along with the inflationary expectation. Paul Volcker, chairman of the US Federal Reserve in the 1980s pushed up the interest rate to historical levels just to kill inflation. His policy was not liked by many but he did it anyway. His weekly pushing of interest rates higher and higher tamed the inflation and he literally save the US economy from hyperinflation.

Dr. Rajan’s job is a thankless one. He is doing his job based upon his and others experiences in other countries. Politicians should not discredit a governor of high repute and integrity. The RBI is an outstanding institution with many stalwarts at the helm over the years. Dr. Rajan’s responsibility is complex. On the one hand he has to protect the commercial banks to ensure their solvency and on the other make sure that the economy is on even keel with good growth and manageable inflation. Currently the NPA of banks are alarming but thanks to the astuteness of RBI it is being currently controlled. The question is can he lower the interest rates just because the economy has gone into a slower growth mode. Currently the lower rates of interest have indeed created a big bubble in the Indian real estate market which is currently bursting in Bombay and Delhi and the prices are plummeting by 20 to 30 percent.

In India everything is scarce except empty words. Shortages and inadequacies are part and parcel of our economy. Look at our unorganized sector. It is horrendously large. We have nearly 100000 branches of banks serving 1.25 billion people. We have nearly 680000 villages and very few of them have bank branches. Therefore the business is done primarily in cash while the costs of funds stay around 40 percent. One of the reasons for inflation is the cost of these funds which gets added on at each level. Also inflation in India is not easily tameable as we import oil from overseas. The imported price of diesel is not in the hands of Indian government. Recently Crude oil prices touched above $ 100 a barrel due to tension in Syria and Ukraine. It is certain that diesel prices will go up after election and this will have a major impact on the inflation rate.

Asking Dr. Rajan to resign from his job is a bad call from the former minister. If he is smart enough he should investigate the Indian food supply chain namely between the farmer and the retail outlet. I seek his help to know why when wheat is selling around 17 rupees a kilo in the future market and Atta the byproduct of it is selling for 44.70 Rs a kilo. If he knew the answer then he will know where the inflation is coming from. Thus going after the RBI governor and accusing him will in no way to solve this issue. Dr. Rajan is a highly respected person of international stature and he is not a politicians’ pawn. We need good men in position to build good institution. Dr. Rajan is doing a creditable job and so leave him for heaven sake so that he can continue to do his job creditably.

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