Warns on the eve of Budget that any deviation from fiscal consolidation path will hurt stability.
New Delhi : Ahead of the Budget, RBI Governor Raghuram Rajan on Friday warned against generating economic growth through additional debt saying that any deviation from the fiscal consolidation path will hurt stability.
He added that macroeconomic stability during these times of global turmoil cannot be risked and the government and the RBI should continue to bring down inflation. “As Brazil’s experience suggests, the enormous costs of becoming an unstable country far outweigh any small growth benefits that can be obtained through aggressive policies. We should be very careful about jeopardising our single most important strength during this period of global turmoil — macroeconomic stability,” he said here.
In this context, Rajan noted that the recent power industry reforms passed by Prime Minister Narendra Modi’s government could force state governments to absorb 75 per cent of the Rs. 4.3 lakh crore held by its utilities, and could inflate the country’s debt levels.
Delivering the CD Deshmukh Memorial lecture, Rajan said there is a public discussion whether India should yet again postpone fiscal consolidation with some arguing that it could lead to higher growth. “Unfortunately, the growth multipliers on government spending at this juncture are likely to be much smaller, so more spending will probably hurt debt dynamics. Put differently, it is worth asking if there really are very high-return investments that we are foregoing by staying on the consolidation path?” he said.
The NDA government had last year deviated from the fiscal consolidation path, postponing reduction in fiscal deficit target by a year. Originally, the target was to bring down fiscal deficit to 3.6 per cent of the GDP in 2015-16 but it has been postponed by a year. Now, government is targeting 3.9 per cent in the current fiscal.
He said that fall in inflation has been on account of the “joint work of the government and the RBI, aided to some extent by the fall in international commodity prices. This is no mean achievement given two successive droughts that would have, in the past, pushed inflation into double digits”. Unfortunately, he added, despite the success there are voices suggesting that we should weaken the fight against inflation.
He said: “Let me reiterate that macroeconomic stability relies immensely on policy credibility, which is the public belief that policy will depart from the charted course only under extreme necessity, and not because of convenience. If every time there is any minor difficulty, we change the goal posts, we signal to the markets that we have no staying power. “Let me therefore reiterate that we have absolutely no intent of departing from the inflation framework that has been agreed with the Government. We look forward to the Government amending the RBI Act to usher in the monetary policy committee, further strengthening the framework.”
Macroeconomic stability, Rajan stressed, would be the platform on which “we will build the growth that will sustain our country for many years to come, no matter what the world does”.
Raghuram Rajan’s dosa economics –
RBI Governor Raghuram Rajan likes to delve into our daily lives to prove how economic precepts work. On Friday, he dipped into “dosa economics” to prove how inflation can be a silent killer. Rajan used the example of a pensioner buying a dosa to explain how he can have more dosas today despite earning lower interest on his savings in bank deposits, as long as inflation stays low. Here is Rajan’s prognosis:
“Say the pensioner wants to buy dosas and at the beginning of the period, they cost Rs. 50 per dosa. Let us say he has savings of Rs. 1,00,000. He could buy 2,000 dosas with the money today, but he wants more by investing.
At 10 per cent interest, he gets Rs. 10,000 after one year plus his principal. With dosas having gone up by 10 per cent to Rs. 55, he can buy 182 dosas approximately with the Rs. 10,000 interest.
At 8 per cent interest, he gets Rs. 8,000. With dosas having gone up by 5.5 per cent, each dosa costs Rs. 52.75, so he can now buy only 152 dosas approximately. So the pensioner seems vindicated: with lower interest payments, he can now buy less.
But wait a minute. Remember, he gets his principal back also and that too has to be adjusted for inflation. In the high inflation period, it was worth 1,818 dosas, in the low inflation period, it is worth 1,896 dosas. So in the high inflation period, principal plus interest are worth 2,000 dosas together, while in the low inflation period it is worth 2,048 dosas. He is about 2.5 per cent better off in the low inflation period in terms of dosas”.
