By Nantoo Banerjee
It will be unfair to expect much from the new Reserve Bank governor, Sanjay Malhotra, a career bureaucrat and former revenue secretary, in terms of delivery of key functions of a central bank chief such as controlling inflation, stabilizing domestic currency, foreign exchange control and lifting economic growth. If three of his predecessors since 2014 – Raghuram Rajan, Urjit Patel, and Shaktikanta Das – were not able to deliver those objectives, there is little reason to expect that the performance of the present RBI governor will be much different.
Shaktikanta Das, also a career bureaucrat and former finance secretary, had the second longest tenure as the RBI governor. Despite that Das achieved little to arrest price inflation, especially for wage goods which concern over 70 percent of the country’s population under the low-and-medium income group, check the slide of Rupee’s exchange value, bring large foreign direct investment, check hot money flow, both inward and outward, stabilize trade and economic growth among others. Rather alarmingly, the Rupee-US$ exchange parity has dipped by over 40 percent since 2014, from Rs.60.34 for one US$ to beyond Rs.85 for a dollar, now.
It is certainly not within the prowess of the RBI governor to independently pursue his functional objectives and be responsible for his success or failure. It’s more often that the RBI governor is seen acting under pressure from the government and politically influential big industrial borrowers. India’s average GDP growth rate over the last 10 years (2013–2023) was 8.5 percent. The average retail inflation rate for wage goods was around nine percent. It is difficult to say how effective the RBI’s interest rate manipulation has been to control such high inflationary trends over the years. The RBI-fixed prime lending rate had little impact on the country’s economy, inflation rates, and consumption. India’s highest bank lending rate was 12.56 percent in April 2012. The average bank lending rate in India from 2012 to 2024 was 10.61 percent. The RBI policies with regard to inflation control, exchange rate stability; economic stability, favourable environment for trade and investment and export push are highly influenced, if not substantially guided, by the government’s own decisions, actions or inactions in these areas. On Paper, the central bank is responsible for monetary policy, which includes determining the money supply, implementing policies to control inflation to help stabilize the currency value.
If the RBI has failed to maintain Rupee’s exchange rate stability, it is because the government has totally failed to make the country substantially self-reliant. The country has become increasingly import dependent, leading to massive trade deficits year after year. This is impacting Rupee’s exchange rate stability. The net foreign direct investments (FDI) continue to be low although the RBI policy is FDI friendly. The RBI can do little to change the foreign investors’ perception of the country and its market, which is basically the government’s job. India’s net foreign direct investment (FDI) during 2024 is expected to be only around US$10.58 billion. The government often blames the growing petroleum imports for the high trade deficit. This is not true. For instance, last year, petroleum imports as a percentage of India’s gross imports (in value terms) was 25.1 percent, down from 28.2 percent in 2022-23. Incidentally, India is also a major petroleum exporter. In 2023-24, the country’s petroleum export as a percentage of its gross exports was 12 percent.
The RBI does make daily decisions on exchange rate interventions. However, it can only go up to a point and not beyond to maintain exchange rate stability. Its role to ensure economic stability and a favourable environment for trade and investment depend largely on the government actions or lack of them. The weakening Indian currency is not helping bumper exports. It is because of the country’s limited export capability for want of a strong government direction over the years. A nation’s currency exchange rate is one of its most important economic health determinants. Along with interest rates and inflation rates, exchange rates play a very important role in a nation’s level of trade, which is critical to the world’s almost every free market economy. That explains why exchange rates are among the most watched and analysed economic numbers, and among those most subject to government manipulation.
Generally, five key factors influence a domestic currency’s exchange rates. The inflation rate and foreign trade balance are considered to be the most important of them. Nations experiencing higher inflation typically see depreciation in their currency versus the currencies of their trading partners. The interest rate manipulation by the central bank is among the most effective ways to control price inflation. A country with a relatively low inflation rate usually experiences a higher currency value, as its purchasing power increases relative to other currencies. In fact, bank rates, inflation, and exchange rates are highly correlated.
Central banks, by manipulating interest rates, exert influence over both inflation and exchange rates. Interest rate changes have an impact on inflation and currency values. Higher interest rates offer banks and other lenders a better return relative to other countries. Higher interest rates attract foreign capital and cause the exchange rate to rise. Large current account deficits and public debt, for which a central bank has little control, are also major exchange rate influencers. Lately, the International Monetary Fund (IMF) had projected that the India government’s debt could surpass 100 percent of its GDP by 2027-28.
Thus, the government of India, not the RBI, is in full command of the country’s economy and trade. The government’s policies are responsible for domestic production, import and distribution. For instance, this year, the government allowed cheaper gold imports to control a portion of surplus money supply with the public. The RBI plays, at best, a second fiddle to the government in stabilising money supply and exchange rate. Thus, it will be unfair to expect the newly appointed RBI governor to achieve a miracle with regard to the stability of the Indian currency, controlling inflation, pushing exports, and keeping the public debt under check. (IPA Service)
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