For policy harmony

Print edition : April 19, 2013

RBI Governor D. Subbarao and Finance Minister P. Chidambaram. Photo: Manvender Vashist

IN the run-up to the review of monetary policy it has now become fashionable for the Finance Ministry to nudge the Reserve Bank of India (RBI) to ease its policy rates to pep up aggregate demand. The central bank hardly obliges at a time when inflation at the retail level remains relentlessly high. In the backdrop of the economic slowdown, the call for a rate-cut has become so cacophonous that the RBI deems it de rigueur to underscore the importance of fiscal-monetary policy coordination.

It has come out with a monograph, Report on Currency & Finance 2009-12: Fiscal-Monetary Coordination, prepared by a team of young officers under the guidance of Executive Director Deepak Mohanty.

While the onset of the global financial crisis saw close coordination between monetary and fiscal policies both at the national level and on a global scale, in the exit stage individual countries adopted diverse strategies to deal with their own concerns. India, too, had two doses of fiscal stimulus in the post-crisis period, though the concomitant flareup in inflation put paid to any easing of policy rates.

The accommodative monetary policy pursued until October 2009 was calibrated between January 2010 and October 2011, while the fiscal consolidation process was resumed in 2010-11, the study said, adding that the resurfacing of downside risks to economic growth in the second half of 2011-12 warranted a pause in monetary tightening. On the fiscal front, government finances worsened with a sharp widening of the fiscal deficit, signalling a marked deviation from the suggested tack of fiscal consolidation. In fiscal 2012-13, the persistence of the economic slowdown and a moderation in inflation in manufactured products led to the easing of monetary policy and the government undertook to contain the fiscal deficit to 4.2 per cent of GDP in the 2013-14 Budget.

It is against this backdrop that the apex bank thought it timely to reflect upon the dynamics of fiscal and monetary coordination. The report highlights the evolution of macroeconomic theory and analyses fiscal-monetary coordination in terms of its macroeconomic and monetary implications. It recalled that the phasing out of automatic monetisation and cessation of the RBI’s participation in the primary government securities market had pared the degree of fiscal dominance. But the apex bank’s open market purchases, though guided largely by the objective of liquidity management, resulted at times in de facto monetisation of deficit, it conceded.

The monograph argues that in the wake of the post-crisis escalation of fiscal deficits, returning to a credible path of fiscal consolidation would require addressing the structural constraints in government finances.

This would mean undertaking far-reaching fiscal reforms that cover both revenue-enhancing and expenditure-cutting measures. The report said the move towards a phased cut in subsidy expenditure would help rebalance public expenditure, while an improvement in the quality of public expenditure could raise the acceptability of greater tax mobilisation. To sustain this, however, is a tall order for a coalition government.

G. Srinivasan

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