High interest rates unavoidable to keep inflation under check, RBI to tell next government

MUMBAI: The Reserve Bank of India (RBI) will explain to the new government the need to keep inflation under control and why keeping interest rates relatively high may be unavoidable to achieve that, government officials familiar with RBI’s thinking said. Further, RBI, which is in the process of formulating new guidelines for bank licences, was unlikely to allow corporate houses to set up new banks in the near future, the officials said.

“RBI will talk to the next government on the importance of inflation control, the inflation target and the need to stay the course which the central bank is following,” said one of the officials. The official said while it was easy to come up with “one-liners” on supply-side problems causing inflation and thus reach the conclusion that rates should be cut, the reality was more complex. “Certainly any improvement on the supply side will help as far as food inflation is concerned,” said one of the officials cited above.

“But inflation goes beyond food and RBI’s efforts is to break the inflationary spiral,” the official added. Another official pointed out that India had the highest inflation and the highest fiscal deficit barring, Argentina, among the world’s major economies.Consumer price inflation rose to 8.31 per cent in March from 8.03 per cent in February.

Key BJP leaders including Arun Jaitley, the leader of opposition in the Rajya Sabha, who is said to be a strong contender for the post of finance minister should the BJP come to power, as well as Piyush Goyal, the party’s treasurer, had expressed reservations about the efficacy of interest rates in fighting inflation. Instead they have called for lower rates to spur production. According to opinion polls, BJP is the front-runner in the ongoing elections.

In the past, Finance Minister P Chidambaram has also favoured lower rates though he has not commented on the matter recently. RBI governor Raghuram Rajan has indicated that he favours inflation targeting — though the target will be set jointly with the government. A report authored by Urjit Patel, a deputy governor, says RBI should aim to bring CPI below 8 per cent by January 2015 and 6 per cent a year later.

Explaining the thinking on bank licences, the officials said RBI was strengthening its supervisory capabilities and systems. At this stage of the “political and economic cycle” when corporates were labouring under high levels of debt and many faced questions on corporate governance, allowing business houses to set up banks could be some time away, said the people cited earlier.

Importantly, the RBI will also “hold a dialogue” with the new government on a number of areas, including the need to present a “credible budget”, the necessity of further financial sector reforms and focusing on the external sector, said the officials, who have been briefed on the RBI’s thinking.

Explaining the concept of a credible budget, one of the officials said containing the fiscal deficit was paramount and this had to be done in a manner so that the numbers carried conviction. “This means that the government must account fully for all expenditure, provide funds for capitalising public sector banks, take an axe to subsidies and introduce broad-based measures to raise revenue,” one of the officials said. Public sector banks needed as much as Rs4 lakh crore to meet Basel norms, the official explained.

One of the officials warned that an unstable government could see capital outflows and threats of downgrades by credit rating agencies. The economy, the official said, was currently skating along at the bottom but growth could pick up by at least one percentage point if measures were taken to unlock projects tied up in red tape. “ We could see growth between 5.5 per cent and 6 per cent, nudging the latter in the second half of the current fiscal,” the official said.