RBI Governor Raghuram Rajan cautions: Don’t overspend to spur growth

Rajan said that macroeconomic stability during the global turmoil cannot be risked and the government and RBI should continue to bring down inflation.

By: ENS Economic Bureau | New Delhi | Updated: January 30, 2016 9:26 am
Raghuram Rajan, Rajan fiscal deficit, Rajan economic growth, Raghuram rajan Indian economy, RBI governor, Reserve Bank of India, RBI news, Raghuram Rajan news RBI Governor Raghuram Rajan. (Source: PTI)

A month ahead of the Union Budget, Reserve Bank of India Governor Raghuram Rajan warned the government Friday against a spending spree to spur economic growth. Citing the example of Brazil, another emerging economy in trouble now, he pointed out that “the enormous costs of becoming an unstable country far outweigh any small growth benefits that can be obtained through aggressive policies”.

Delivering the C D Deshmukh Memorial Lecture in New Delhi, Rajan said: “Unfortunately, the growth multipliers on government spending at this juncture are likely to be much smaller, so more spending will probably hurt debt dynamics. Put differently, it is worth asking if there really are very high-return investments that we are foregoing by staying on the consolidation path.”

He said the country was already grappling with an increase in the aggregate fiscal deficit during the last calendar year, even as a newly implemented power reforms scheme would likely strain finances of state governments further next fiscal.

He also reiterated that the central bank would not change its monetary policy strategy of targeting inflation, saying that doing so would hurt policy credibility.

“As Brazil’s experience suggests, the enormous costs of becoming an unstable country far outweigh any small growth benefits that can be obtained through aggressive policies. We should be very careful about jeopardising our single-most important strength during this period of global turmoil, macroeconomic stability,” Rajan said.

Last year, the government deviated from the fiscal consolidation path, postponing reduction in fiscal deficit target by a year. Finance Minister Arun Jaitley had redrawn the fiscal consolidation roadmap, stretching the time to reach the fiscal deficit figure of 3 per cent of GDP from two years to three years and setting the fiscal deficit target at 3.9 per cent for 2015-16, 3.5 per cent for 2016-17 and 3.0 per cent for 2017-18.

Rajan said that the consolidated fiscal deficit of the Centre and states had risen to 7.2 per cent in 2015 from 7 per cent in the previous year. “So we actually expanded the aggregate deficit in the last calendar year. With UDAY, the scheme to revive state power distribution companies, coming into operation in the next fiscal, it is unlikely that states will be shrinking their deficits, which puts pressure on the Centre to adjust more,” he said.

He said while there is a public discussion whether the fiscal consolidation roadmap should be postponed and instead engage in fiscal expansion to generate growth, it may not hold true for India.

“Of course, the common man does not really care whether we stay on the consolidation path or not. But the bond markets, where we have to finance over Rs 10 lakh crore of deficits plus UDAY state bonds, do care. Deviating from the fiscal consolidation path could push up government bond yields, both because of the greater volume of bonds to be financed and because of the potential loss of government credibility on future consolidation.”

Stating that the fall in inflation has been on account of the “joint work of the government and the RBI, aided to some extent by the fall in international commodity prices”, he said this was “no mean achievement given two successive droughts that would have, in the past, pushed inflation into double digits”. He added though that despite the success on the inflation front, there were voices suggesting weakening the fight against inflation.

“Let me reiterate that macroeconomic stability relies immensely on policy credibility, which is the public belief that policy will depart from the charted course only under extreme necessity, and not because of convenience. If every time there is any minor difficulty, we change the goal posts, we signal to the markets that we have no staying power,” he said.

“Let me, therefore, reiterate that we have absolutely no intent of departing from the inflation framework that has been agreed with the government. We look forward to the government amending the RBI Act to usher in the monetary policy committee, further strengthening the framework.”

Macroeconomic stability, Rajan said, would be the platform on which “we will build the growth that will sustain our country for many years to come, no matter what the world does”.

He also cautioned against raising tariffs to protect domestic industries facing problems. The RBI is scheduled to announce the next bi-monthly monetary policy on February 2.

Rajan began the lecture by stating that though the RBI is in “fine fettle”, the world today is much less comforting as industrial countries were still struggling, with a few exceptions, to grow. “Our fellow BRICS all have deep problems, with confidence about China waxing and waning. Indeed, India appears to be an island of relative calm in an ocean of turmoil,” he said.

Citing the example of Brazil, which is facing double digit inflation, he said it is confronted with financial problems because it tried to grow too fast on the back of substantial stimulus.

“While the Brazilian authorities are working hard to rectify the situation, let us not ignore the lessons their experience suggests. It is possible to grow too fast with substantial stimulus, as we did in 2010 and 2011, only to pay the price in higher inflation, higher deficits, and lower growth in 2013 and 2014.”

“Of course, India is not in the same situation today. Given the inhospitable world economy and two successive droughts, either of which would have thrown the economy into a tailspin in the past, it is to the immense credit of the government that we have over 7 per cent growth, low inflation, and a low current account deficit. But it is at such times that we should not be overambitious,” he said.

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  1. B
    Jan 29, 2016 at 5:27 pm
    Since you found fault with Great Modinomics, I declare you TODAY's , COMMIE, NAXALITE. Tomorrow I will on the lookout for whom to be bed.
    1. W
      Jan 29, 2016 at 10:37 pm
      I love to hear such things from an IITian in Electrical Engineering, who decided to become a high paying CLERK and destro the career of an enthusiastic potential Electrical Engineer. Raguram Rajan is an excellent example of how brahmins have been systematically destroying India. Not a single brahmins who get their IIT admission through their UNCLEs(MAMAs) aspires to be in India after their graduation. And those MAMAs knew that. ONLY HINDUS, MUSLIMS, CHRISTIANS, JAINS, (in other words HUMANS) like you and me DO NOT KNOW WHAT THE F IS GOING ON FOR 68 YEARS!!!
      1. I
        Jan 30, 2016 at 5:32 am
        He was one of the few people who predicted the 2009 bubble in the US. I have heard him speak, I have friends of mine who took cles in corporate finance from him. We all have nothing but praise for his articulation of complex issues in simple language. His appointment as RBI governor was one of the better things any govt has done. Modi was smart enough to realise this and kept him. Whatever he has taken up he has done well. You have a problem with that ??
        1. A
          Apoorv Swarup
          Jan 30, 2016 at 6:02 am
          I think the government too is well aware about this. Excerpts from various interviews of Mr. Jaitley clearly indicated that the government intended to increase aggregate demand initially through heavy public investments in infrastructure and farm irrigation. Subsequently due to the effected reforms (which have all been currently stalled by the Congress in the Upper House) mive private investment was to take the growth forward (i.e. pension fund money/ FDI/ Sovereign wealth funds etc.). The more the reform process is dela the more untenable the existing regime of mive public expenditure becomes with time. Its a pity that a party which was routed by virtually the entire country can threaten and hold an entire country to ransom.
          1. A
            Arun Bhalerao
            Jan 30, 2016 at 5:57 am
            RajenEconomics Everybody makes their own Economics. The other day Mr. Raghuram Rajan, Governor of our Reserve Bank, was explaining to students that how only growth in GDP is not sometimes desirable for Economy. Explaining the argument, he gave an example of two mothers babysitting each other’s children and paying each other equal ry will increase the GDP but will not benefit Economy. Here is how the situation of Mothers A and B babysitting each others’ children will benefit the Economy: 1) When two mothers go out of their respective homes for babysitting, they will spend on more presentable dresses, cosmetics and travel. Apart from Babysitting ry, this expense would benefit the Economy immensely. 2) Husbands of respective houses would have good motivation in the housework and general upkeep of the house, since “other” woman is visiting for babysitting. 3) Normal mothers do their children’s upbringing as per time and means available to them from time to time. This may not be always be of professional quality. ( Children who suffer the deficiencies of their mothers would be good evidence for vouching for this.). When another mother is coming to your house for babysitting, the babysitting would be of much better and since is being paid for, would be of Professional quality. 4) Children in each house need not suffer their mother’s whims, since now they will be influenced by visiting babysitter mother. Hence we can expect a better quality future generation. 5) Since mother A is babysitting mother B’s children, the society in general would have more diverse methods of upbringing and due to such baby-sitting visits the society would be more tolerant and more pluralistic and that would benefit the naion. Mr. Rajen would have perhaps given better example if he was raised by some other Nobel-winner’s mother instead of his own biological mother. -----Arun Bhalerao ----------------------------------
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