Once upon an 8%

The budget must focus on reviving growth. The rest will fall into place

Conducting fiscal and monetary policies in what appears to be a phase of stagflation can be a huge challenge for any government. Even economic literature seems unclear on how you deal with a situation when growth dips sharply and the inflation rate remains stubbornly high. After dithering for nine months, the RBI finally decided to cut the repo rate (interest rate at which the central bank lends overnight to banks) as a signal that it was willing to recognise the risk to growth as a more dominant concern than the persisting problem of inflation. The RBI pleasantly surprised the market by cutting both the repo rate and the cash reserve ratio (CRR) of banks by 25 basis points each. The central bank probably got a bit alarmed that, on a sequential basis, GDP growth in the third quarter of 2012-13 may actually be down to 4 per cent, which seems closer to the old Hindu rate of growth seen in the 1960s and '70s. The RBI, therefore, decided this time that it would shift its focus largely to growth risks. It was possibly this change in thinking that resulted in a surprise reduction of the repo rate and the CRR.

The stagflation-like situation (so far, nobody is officially admitting to stagflation, though we have had 15 months of persistently high inflation and falling growth) had also created a sort of gulf in communication between the Centre and the RBI. The RBI had primarily remained focused on inflation risks through 2012, and the then finance minister, Pranab Mukherjee, just could not get the central bank to look more at the dramatic decline in growth from the 2010 peak of over 8 per cent.

The central bank's stance was that it could ease monetary policy only if the finance ministry showed it was serious about controlling the runaway fisc and helped in managing food inflation through better supply measures. RBI was clear that money supply could not be eased when inflation risks were persistent. For a while, the RBI refused to budge from this position, even after Finance Minister P. Chidambaram took charge last August and gave a public commitment to rein in the fisc. In my view, there were two major factors that enabled the central bank to finally take the decision to cut the repo rate, after a hiatus of nine months.

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