Govt must protect central bank's independence: Rajan

Raghuram Rajan rejected the argument that inflation has come down largely because of "good luck" stemming from low oil prices.

Taking on his detractors, Governor Raghuram Rajan on Tuesday said the criticism that RBI killed growth with high rates was at odds with "received wisdom" of India being fastest-growing and urged the government to look beyond 'motivated criticism' to protect the central bank's autonomy.

The outgoing Reserve Bank chief also rejected the argument that inflation has come down largely because of "good luck" stemming from low oil prices and not because of RBI's monetary policy measures, saying a significant part of decline in global prices has not been passed on domestically as the government has hiked excise on petrol and diesel.

Rajan, who has decided against a second term amid a spate of attacks including some of personal nature, rejected the criticism that he has kept the monetary policy "too tight" and blamed the slowdown in credit growth largely to stress in the public sector banks, stemming from "past mistakes in lending".

He also appeared to blame "over-leveraged promoters" for voices against the clean-up at banks and said "some public sector bank CEOs with a short remaining tenure would prefer not taking stern action and recognizing NPAs" as they might "prefer transferring any problems to their successor".

He also said that investors in bank shares do not welcome disclosures of loan losses initially, while "depositors, knowing the government stands fully behind PSU banks, are rightly unperturbed by the quality of bank balance sheets".

Rajan said high inflation has "pernicious effects" on the weaker sections and wondered why there was so "little anxiety" over the price-rise scenario.

"Without any political push back as inflation rises, it is necessary to build institutions to ensure macroeconomic stability...perhaps this is why successive governments, in their wisdom, have given the RBI a measure of independence," said Rajan, who will return to academics when his three-year term ends on September 4.

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Hitting back at the critics who have blamed him for keeping rates too high and thus killing demand and growth while failing to even control inflation, Rajan said, "Critics offer two contradictory arguments on inflation".

"On the one hand, they argue that we have killed demand and growth through high rates – though this itself seems at odds with the received wisdom that we are the fastest growing large economy in the world.

"On the other, they argue that our policy has had little effect on curbing inflation, that disinflation has been a result of the fall in oil and other commodity prices."

Rejecting these arguments, the former IMF Chief Economist said in a lecture here that the disinflation process started in late 2013, long before oil prices collapsed.

"Moreover, a significant part of the fall in oil prices globally has not been passed on domestically, as the government has hiked excise on petrol and diesel, and refinery margins have also waxed and waned.

"For instance, even as the price of the Indian crude basket fell 72 per cent between August 2014 and Jan 2016, the pump price of petrol fell only 17 per cent. Therefore, while I do want to acknowledge the benign global price environment in bringing down inflation, it is not the entire story."

He further said the criticism of the central bank with arguments unsupported by evidence happens outside India too.

Giving examples of the UK and US among other places, Rajan said, "Criticism comes with the territory, and central banks need to make the case for their policies."

"At the same time, it is important that governments around the world look beyond sometimes uninformed and motivated public criticism and protect the independence of their central bank to act. That is essential for stable sustainable growth."

Addressing the 10th Statistics Day Conference at the RBI headquarters in Mumbai, Rajan termed the criticism of central banks' policies without evidence as a "widespread" phenomenon and cited how most of them, including the Bank of England, the US Fed and the European Central Bank (ECB), are facing flak.

Talking about India, he said, "The press is constantly urged to frame the debate as inflation versus growth, and with inflation still moderate, only the excessively conservative central bank could be against growth!"

Citing past trends, he also warned of a crisis scenario if inflation is not contained.

"As we have seen in India's own past, and in other emerging markets, moderately high inflation tends quickly to become very high inflation. The currency then becomes volatile, leading occasionally to external stress. After all, one of the reasons we were termed the Fragile Five in the summer of 2013 was because of our high inflation.

"Moreover, the saver eventually recognises that high inflation erodes the value of his financial savings and switches to real assets like gold. Since we do not mine gold in the country, this also puts pressure on the current account. In sum, the fragilities associated with high inflation accumulate, and eventually could lead to crisis."

"However, the belief that there is a strong powerful domestic constituency against inflation in India, which was drummed into our heads as students, may be a myth, certainly at moderately high levels of inflation. Without any political push back as inflation rises, what is to ensure macroeconomic stability?" he wondered.

Rajan further said that unlike "more authoritarian Asian economies" that used severe administrative measures to deal with bouts of high inflation during their growth phase, India's "democratic structure rightly does not permit such measures".

"So it is better that we tackle inflation up front by building the necessary institutions. Perhaps this is why successive governments, in their wisdom, have given the RBI a measure of independence.

"Certainly, such concerns would support the current government's decision to enshrine its commitment to low inflation through a formal inflation target and the creation of a monetary policy committee," he added.

It can be recalled Rajan faced attacks from a section of ruling BJP - notable among them Rajya Sabha MP Subramanian Swamy - for the way he has kept interested rates, which they alleged "killed" the domestic industry, especially the SMEs.

Rajan was also criticised by some for his statement comparing the India's 'fastest-growing' tag to the 'one-eyed king in the land of the blind'.

Amid all this, Rajan on June 18 announced he would not opt for a second term and return to academics.

In his lecture, Rajan admitted the Reserve Bank should have acted against loan defaulters earlier by pushing for a clean-up as is being done now.

"As with inflation, it was the duty of the Central bank to press for bank clean-up earlier," he said.

He said there is a belief in some quarters that the RBI has hurt economic growth by keeping interest rates and borrowing costs too high and that high rates have reduced credit and spending but had little effect on inflation.

"Inflation has come down only because of good luck stemming from low energy prices. Furthermore, the RBI has compounded the growth slowdown by urging banks to clean up their balance sheets."

Asserting that RBI stands by its policies, Rajan presented some charts to support the rationale for the central bank's actions and to show that "monetary policy has not been too tight".

"Instead, I will argue that the slowdown in credit growth has been largely because of stress in the public sector banks, stemming from past mistakes in lending. This will not be fixed just by a cut in policy rates. Instead, what is required is a clean-up of the balance sheets of public sector banks, which is underway and needs to be taken to its logical conclusion," he said.