Posted by: Deepa Vasudevan on Tue, Mar 10th, 2015
Who won? Who lost?
On February 20, the RBI and the Government of India signed a historic agreement granting RBI the freedom to and responsibility of maintaining inflation within a target range. On February 28, the Union Budget announced an increase in public investment, and a slight worsening of fiscal deficit next year. On March 4, the RBI governor unexpectedly cut interest rates by another 25 bps. This conversation, we imagine, took place before all these momentous events played out...
Characters: The Finance Minister (FM), The RBI governor (RR)
FM: Governor, I have a fantastic budget planned out. Markets will go mad!! Why don’t you cut interest rates and add to the fun?
RR: Umm..inflation expectations remain deeply entrenched..
FM: अरे भाई, wholesale inflation is running negative. What more do you want? बच्चे की जान लोगे क्या?
RR: Sir, we need to clean up our act to destroy inflation once and for all.
FM: No problem! The cleaning up is taken care of. I am going to increase the Clean Energy Cess. And Swachh Bharat Abhiyan is top priority.
RR: You misunderstand me, Sir. I was talking about cleaning up government finances. Building a bullet-proof balance sheet.
FM: You’re as stubborn as these foreign rating agencies. I managed the deficit this year, didn’t I?
RR: But you have pushed it up for next year.
FM: Let’s make a deal. You manage inflation, I will manage the budget.
RR: But Sir, much of the inflation is supply-side driven and fuelled by fiscal profligacy. Monetary policy is really ineffective in this situation.
FM: Look, I’ll sweeten the deal. Throw in 70,000 crore for infrastructure. We’ll figure out some schemes to get the gold into our coffers, and use it to build roads. अब तो खुश?
RR: I appreciate that despite a slippage in quantity of deficit, the quality of the fiscal deficit is improving.
FM: Absolutely. तो बात पक्की.
And that is how, we like to think, the work of managing this complicated economy was divided between RBI and the government of India. Here is a snapshot of their job descriptions.
RR: I won! I gave up just 25 bps, and got my very own inflation targeting Central Bank!
FM: I won! I just budgeted some money for roads, and got the rates down and markets up!
Aam Aadmi: Oh well. I still have my gold. I’m not giving that to anyone.