RBI governor Rajan vocal about inflation fears

Govinda Rao supports Rajan's call for stepped up capex

RBI governor Rajan vocal about inflation fears

RBI Governor Raghuram Rajan has been vocal about his concerns on the inflation front in the second bi-monthly policy review statement.

“Assuming reasonable food management, inflation is expected to be pulled down by base effects till August, but to start rising thereafter to about 6 per cent by January 2016,” he said.

This implies that inflation could rise further if food management is inadequate. He has identified three risk factors for inflation. One is the forecast of below-normal monsoon. Second, Rajan has cited how crude prices have been firming up. Finally, he has pointed out volatility in the external environment. Additionally, Governor Rajan in his policy statement said increase in the service tax rate to 14 per cent could also turn inflationary.

When contacted, M Govinda Rao, former member, fourteenth finance commission, and emeritus professor, National Institute of Public Finance and Policy, said the inflation risks cited in the policy review statement were real. He supported Rajan’s contention that a poor monsoon could constrain the policy space. Also, he noted that the US Federal Reserve is expected to hike rates by around September. According to Rao, the 25 BPS cut in repo rate is quite appropriate even though some hawks were demanding a 50 BPS cut.
Rajan had said that though a conservative strategy would have been to wait out on a rate cut, a more appropriate stance is to front-load a rate cut today and then wait for data that clarify uncertainty.

On this, Rao said he had the impression that “there has to be a significant change in the environment if Rajan has to again cut interest rates. It almost gives the impression that there won’t be further cuts in interest rates, unless inflation moderates and the industry doesn’t revive adequately”.

‘Service tax not inflationary’

Rao, however, discounted the rise in service tax rates as a factor leading to rise in inflation. “The fears on account of the increase in service tax are imaginary. It changes only the relative prices, but there is no increase in aggregate demand.” To combat inflationary pressures, Rajan had recommended “a fuller government policy thrust that hinges around a step-up in public investment in several areas that can also crowd in private investment”.

Rao said the governor seems to be asking the government to cut down consumption expenditure. “The fiscal deficit was originally targeted at 3.6 per cent for 2015-16, but the government pushed it up to 3.9 per cent. But the additional fiscal space has not gone to capital expenditure. And transfers to states were not significantly higher. The governor seems to be saying, release more for capital expenditure, viability gap funding, and accelerate investment in public enterprises.”

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