“Criticism of the central bank using arguments unsupported by evidence is widespread. The Bank of England was criticized for laying out the economic costs of Brexit, the ECB has been criticized for doing too much to restore health to troubled peripheral economy financial sectors, and the Fed is under fire for departing from the Taylor Rule. Criticism comes with the territory, and central banks need to make the case for their policies. At the same time, it is important that governments around the world look beyond sometimes uninformed and motivated public criticism and protect the independence of their central bank to act. That is essential for stable sustainable growth.”

Dr. Raghuram Rajan, Governor, Reserve Bank of India said this while addressing the 10th Statistics Day Conference 2016 held in the Reserve Bank of India, Mumbai on July 26, 2016.

Highlighting the need for using data and evidence to shape policy debates, the Governor gave two examples - inflation and cleanup of bank balance sheets – two initiatives of the Reserve Bank of India. With the help of charts, he showed that the slowdown in the growth of non-food credit by public sector banks was probably not because of lack of demand or capital; nor was it because of high interest rates but largely because of stress in public sector banks, stemming from past mistakes in lending. “This will not be fixed just by a cut in policy rates. Instead, what is required is a clean-up of the balance sheets of public sector banks, which is underway and needs to be taken to its logical conclusion,” he stated.

Worrying that there was little anxiety in the public commentary when inflation was moderately high, the Governor argued it had pernicious effects on the weaker sections of society and stated that the fragilities associated with high inflation accumulate, and eventually lead to crisis. “The best way central banks can support growth over the medium term is by keeping inflation low and stable,” he said and added that “Without any political push back as inflation rises, it is necessary to build institutions to ensure macroeconomic stability.” “Perhaps this is why successive governments, in their wisdom, have given the RBI a measure of independence.” Such concerns would also support the current government’s decision to enshrine its commitment to low inflation through a formal inflation target and the creation of a monetary policy committee.

According to the Governor, as with inflation, it was easy to ignore the problem of loan losses and hope it somehow goes away. But as with inflation, loan losses had a tendency to increase, get too big to ignore, too late to manage, and push the system into crisis. Fortunately, after an initial reluctance, banks have entered the spirit of the cleanup and some have gone beyond what was demanded of them. The stock market, after reacting negatively initially early this year, was more supportive of public sector bank stock prices, probably reflecting the belief that the cleanup was good over the medium term. Promoters were selling assets and paying up, and new asset reconstruction companies were being started to buy assets. As with inflation, therefore, it was the duty of the central bank to press for bank clean up earlier, when few among the public support the central bank’s activism, the Governor concluded.

Alpana Killawala
Principal Adviser

Press Release : 2016-2017/226