There has been serious debates in the media on the conflict of issues between the Finance Ministry and the RBI. I have tried to capture these issues in the form of communication between the FM and the Governor for better and easy understanding. Enjoy reading....here goes the chat....
Governor to FM: I have been running tight monetary policy since March 2010 and have hiked the operative policy rate from 3.25% to 8.5% to get headline inflation down to 7%. I have done my job well. I am now gearing up to get the print below 6% by end of FY13.
FM to Governor: But, this has added pressures on me as my GDP growth is down to 7%; my revenues are under severe pressure; I cannot cut subsidies and can’t think of any kind of reforms to get the growth back on track. I don’t have enough support in the Parliament or deep pockets to get out this pain; please bail me out by releasing your grip on the monetary policy.
Governor to FM: The impact of cost subsidisation continues to keep real inflation at elevated levels of 9-10% and I will have comfort to get into loose monetary policy only when headline inflation falls below 4% to cover subsidy cost; thereby keeping real inflation around acceptable 6-7%. Moreover, I am closely watching price of BRENT Crude; it needs to go below $115 to limit the cost subsidisation below your target of 2% GDP for FY13. Rupee is also weak and we continue to stay dependent on external flows; there seems to be no solutions to address the huge Current Account Deficit.
FM to Governor: I know and all these are structural issue; I also don’t have control over external factors but it will be tough to handle internal forces (within and outside UPA) if I don’t meet my targets in FY13. I missed the FY12 targets by big margin and I don’t want to have a repeat under performance in FY13.
Governor to FM: I understand your position but my hands are tied till I get comfort on sharp downtrend in inflation driven by significant fall in BRENT Crude and dilution of rupee impact on inflation. I also have my doubts to achieve FY13 fiscal deficit of 5.1%; which will be sharply down from FY12 actual of around 6%. The economy is in “business as usual” mode and it would be hard to fix this 1% gap between FY12 actual of around 6% and FY13 estimate of around 5%.
FM to Governor: Everything is ganging up against me and I want support from monetary policy to fix this gap. The system is short of cash; money supply is down; rates are up; investor confidence is bad; consumer sentiment is weak and all will start looking good only when you get into loose monetary policy. Else, achieving my growth and revenue targets will be extremely difficult and fiscal position will turn from bad to worse.
Governor to FM: Unless you give comfort on fiscal deficit and ability to limit cost subsidisation, it will be very difficult for me to go soft on monetary policy
FM to Governor: Unless you do this, it is impossible for me to provide comfort to you on fiscal deficit and avoid overshoot in cost subsidisation beyond 2% of GDP
Governor to FM: Where we go from here? Your deliverables are dependent on me and my deliverables are dependent on you....
FM to Governor: We cannot afford to sink together; we have to find a way out so that both are safe (communication ends without solutions).
Economy Stake holders (who overheard this conversation): Who will bell the cat? Who will take the first step of compromise?? FM could do very little at this stage. If at all, the Governor can help. High real inflation is major risk to growth; low growth is major risk to inflation and combination of low growth and high inflation is major risk to fiscal consolidation. Is there a way to get out of this vicious trap? Tough times ahead...................
Moses Harding
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