Raghuram Rajan defends rate moves, cites inflation focus

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In his first public appearance since announcing he will step down at the end of his tenure in September, Reserve Bank of India (RBI) governor Raghuram Rajan said there is a trade-off between growth and inflation, and that RBI was wise to disregard advice for further rate cuts as only low inflation can fuel high growth.

Delivering the foundation day lecture at the Tata Institute of Fundamental Research, Rajan said, “Policymakers do not have the luxury of inconsistency. If we stay on same course to target inflation then the poor will not suffer disproportionately due to bouts of sharp inflation, and the middle class will not see its savings eroded. The government will be able to borrow at low rates, and will be able to extend the maturity of its debt.”

The currency has been stable as investors have gained confidence in our monetary policy goals, and this stability will only improve as we meet our inflation goals. Foreign capital inflows will be more reliable and increase in the longer maturity buckets, including in rupee investments. This will expand the pool of capital available for our banks and corporations.

He said if the the central bank were to cut interest rate by 100 basis points today, and banks pass it on, then demand will pick up and we could get stronger growth for a while, especially if economic players are surprised. The stock market may shoot up for a few days.

“But you can fool all of the people only some of the time,” Rajan said emphasising on the importance of not playing to the gallery on interest rates.

He also stressed on the improving borrower behaviour of the large corporates in India to lower rates rather than push RBI to lower rates.

“Far more useful in lowering borrowing rates is to improve lending institutions and borrower behaviour to bring down the credit risk premium than to try and push the RBI to lower rates unduly.”

He said the bank lending rates were not commensurate with policy rates.

“We can never abandon inflation to focus on growth,” he said, but added that the best way the monetary authority can support growth over the medium term is to anchor inflation at low levels so that policy rates can also be low.

Rajan said India is charting a revolutionary path by focusing on low inflation by abandoning the ways of the past that benefited the few at the expense of many.

The monetary policy committee, he said, will internalise the frameworks of inflation targeting which would then produce a low inflation future for India.