Subbarao is RBI governor till 2013

Speculation that the government may want a more pliant governor at the helm of the central bank proved to be bunkum. The government announced that D Subbarao would be the governor of the Reserve Bank of India, for two more years, providing continuity on the monetary policy front. He will now retire as the RBI governor on September 4, 2013.

In end-July, the Reserve Bank of India had hiked benchmark interest rates by 50 basis points stating that it needs to bring inflation down on its knees and that it was compensating for lack of action on the fiscal front to rein in inflation. Some found the rate hike too harsh and also felt that criticising the government, even if it was subtle, seemed to indicate that this might be the governor’s last credit policy as his term was to expire in September. The RBI has said that inflation has to come down, even if growth becomes a casualty in the short run. Read the governor’s policy statement here.

Not only were they wrong, but the UPA government has done the right thing as this ensures that the RBI’s policies and strategy to bring inflation under control are given continuity. In fact, when the 50 basis point repo rate hike was announced, the finance ministry issued a statement supporting the RBI’s decision and did not even obliquely hint at the growth-inflation trade-off, as it has done in the past.

The move is also significant as it comes at a time when global financial markets are in a soup, with the US credit rating downgrade articulating what everyone knew, and the economic woes in the euro zone becoming more widespread. The RBI governor played a stellar role in ensuring that India was protected from even the limited harm that it could have suffered.

That experience would be invaluable in steering India through troubled times, since global financial markets and the world economy  both are likely to face rough weather. He faces an unenviable task. His focus so far has been to lower inflation and inflationary expectations. If the business environment turns dark, his task of keeping interest rates high will become tougher.

Some part of the blame for India’s high inflation falls on the central bank, as it was too slow to hike rates, when it was clear that inflation was looking like it could get out of hand. The RBI was in sync with the government then, saying that growth is also a priority and that inflation was due to supply bottlenecks.

But now, the RBI has accepted that sellers have pricing power and that is what is driving prices up, and not just supply bottlebecks or international prices. The RBI’s challenge is to bring inflation down, keep it there, whlie at the same time, be careful that high interest rates do not slow growth down abruptly. A soft landing for growth is what the RBI needs.

Read the government’s one-line announcement on extending the governor’s term here.

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