FM does well to downplay talk of policy differences
Given how most news reports on finance minister Arun Jaitley’s speech at the make-in-India workshop focussed on his interest rate remarks and played them up as an attack on RBI Governor Raghuram Rajan, it is just as well that the finance minister has clarified, in a Facebook post, that this was neither an attempt to influence or run down Rajan. To be sure, Jaitley did say the cost of capital was the one singular factor that had contributed to the manufacturing slowdown, but this came after the finance minister had reeled off several other factors holding back Indian manufacturing. Jaitley began by talking of the unfriendly tax regime, of poor trade facilitation, poor quality/availability of electricity, lack of labour flexibility, courts shutting down mining in certain states, poor quality of arbitration … in other words, the list of things holding back manufacturing is a long one and, as Jaitley put it, arose from a lack of shared vision; and this was not just across political parties, it was across various arms of the state as well.
Whatever the differences between the finance minister and the RBI Governor, this is the right way to handle things. There is no doubt, as FE has been arguing for many months now, RBI is being too hawkish by not cutting interest rates and is fighting inflation devils that were slain many months ago. Had repo rates been cut, this would have prompted banks to lower lending rates and would have nudged the credit cycle. Indeed, if things have come to this pass, Jaitley must share part of the blame since, as finance minister, he remained a silent bystander while RBI moved from the old model to a CPI-based inflation focussed one—in his maiden budget speech, Jaitley even spoke of the need to have a modern monetary policy framework which is economists’ shorthand for an inflation-targetting policy. Also, in the short run, cutting capital expenditure to meet fiscal deficit targets will probably do more damage to the economy than RBI not cutting interest rates—in any case, most analysts are pencilling in large cuts after March.
While Jaitley will probably get an occasion to revisit the monetary policy framework in the finance ministry’s discussions with RBI, the two need to work in close coordination to iron out other problems. Were RBI to slash repo rates, the fact is corporates are not in a position to borrow dramatically higher sums due to their excess leverage. Tackling this requires both RBI and the finance ministry to be on the same page. Even though it may seem desirable for the central bank to allow more forbearance for stuck projects being cleared, RBI needs to be careful given the high NPA levels. Similarly, if RBI wants to lower bank exposure norms for corporates, from 40% of net worth right now to 25%, this has to be done with the finance ministry in the loop. Ditto for Rajan’s plans to complete ‘missing markets’ like the corporate bond one as well as for converting trade receivables to an electronic and tradeable format to increase credit availability for MSMEs—Rajan’s 100-small-steps, according to him, will add 1-2 percentage points to India’s GDP growth and so are something the finance ministry would also welcome. The banking conclave in Pune later this week would be a good place for RBI and the finance ministry, along with the banks, to brainstorm on repairing bank balance sheets while getting investment back on track.