The special commentary series this newspaper ran—the fourth analysis appears today—anticipating tomorrow’s monetary policy review puts a few key issues on the debating table. Trying to read Reddy, our columnists have argued the following: 1) If we try to manipulate the rupee down to a particular dollar value while running a tight monetary policy when the US Fed is running a loose one, we paint ourselves into a policy corner. 2) Exports can survive, indeed do well, even when the rupee appreciates; that it is India’s domestic demand and not its external demand that’s more likely to get hit by some of the structural shifts taking place. 3) Domestic investment and consumption demand are weakening and are quite likely to weaken further. 4) The most desired means to combat inflation from the monetary policy perspective is allowing the rupee to appreciate. 5) An interest rate hike, or even other kinds of monetary hardening, will not address inflation, but can very seriously hurt economic prospects. Now, of course, the big question is what YV Reddy will do tomorrow. There may be, optimists expect, small signals on monetary hardening that may not have a big impact down the months—don’t forget, monetary policy effects are lagged—on the real sector. If that is the best-case scenario, should we be satisfied? Not really.
There are a couple of fundamental issues at stake here. First, we need to see evidence of a stable inflation fighting policy, if fighting inflation is to be RBI’s main aim. That stability will come when the central bank doesn’t want to manipulate the exchange rate. As has been argued many times, RBI can target inflation or exchange rates—there’s an unresolved debate on this, rekindled by the Raghuram Rajan committee report—but if it tries to do both, the costs are high. The second issue is even more radical. Why not make the central bank an objective stakeholder in the growth process? Why not debate inflation tolerance levels, and let conventional wisdom be questioned? Why not ask what should be the optimum inflation level from the national economic point of view if everyone agrees that the economy should grow at around 9% for some years? Does this sound heretical? Remember, economic reforms were branded a heresy in the early 1990s.