Monetary policy is mostly a decision about interest rates and therefore on the surface, seems least complicated. However, the drivers of monetary policy can be many and communicating them, much more difficult. Reserve Bank of India Governor Shaktikanta Das leaned on the Mahabharata’s main character Arjuna to explain what drives interest rate decisions. That is strange! What does Arjuna have to do with inflation or growth? Das is not the first RBI Governor to draw analogies from the epic. Duvvuri Subbarao invoked the plight of Abhimanyu and the Chakravyuh when he was faced with a reversal of easy monetary policy. Arjuna and Abhimanyu, although father and son in the epic Mahabharata, are completely different characters. While one emerged victorious in the war, the other was killed. Does Das’s analogy with Arjuna signal victory? What does it mean now to invoke Arjuna for money politics?
What is different between Arujuna’s focus on a parrot and his aim at the eye of the fish?
Das recently spoke about the nature of two different challenges faced by Arjuna. The first was when he was told to aim for the eye of a wooden bird on a tree. During that challenge, Arjuna aimed only at the bird’s eye and was blind to his surroundings. Das often spoke of ‘Arjuna’s eye’ to drive home the RBI’s single-minded focus on bringing inflation back to its 4% target. The second analogy provided by Das on Wednesday was about a later test faced by Arjuna, in which the legendary archer was told to shoot a spinning fish by looking at its reflection in the water. In doing so, Arjuna had to take into account many considerations including the ripples in the water and the wind, Das said. Drawing from this, the RBI Governor then said that while the central bank is focused on bringing inflation to 4%, it considers several other factors while making policy decisions.
What are the issues that are emerging now beyond inflation targeting, which is required by law?
The RBI is mandated by the government to maintain inflation at 4% with the central bank allowed a tolerance band of 2-6%. However, the RBI also has another objective – to create conditions that are conducive to economic growth. While the RBI’s preamble puts price stability – or inflation – ahead of growth, it says the central bank seeks to maintain price stability “keeping in mind the objective of growth”. Around the world, and especially in advanced economies such as the United States and Europe, rapid policy tightening by central banks has resulted in events that have shaken financial stability. Given the volatile international environment, the key issues that come to the fore are financial stability, growth and external flows.
How does financial stability play a role in monetary policy?
Financial stability includes the proper functioning of a country’s financial institutions and financial markets. The RBI tries to ensure that its policy actions do not pose risks to financial stability. During the COVID crisis, when lockdowns dealt a massive blow to economic growth and raised the risk that financial markets would grind to a halt, the RBI’s stance put growth ahead of inflation and said its priority was to mitigate the impact of COVID while controlling inflation. The rapid rate hikes by most central banks around the world from 2022 have posed risks to financial stability by causing huge losses on banks’ government bond portfolios and making it more expensive to access liquidity. Earlier this year, a number of US banks and Swiss banking giant Credit Suisse collapsed under the stress and had to be bailed out. Das said Indian banks have not suffered the same fate despite the RBI’s rate hikes as the central bank has instituted several norms for banks to manage their bond portfolios.
Why should the RBI bother about spillovers?
International spillovers, especially of commodities such as crude oil, have a major impact on India’s economy. This is because India is a very large importer of crude oil, which is denominated in US dollars. Geopolitical conflicts, such as the wars in Europe and the Middle East, usually tend to raise crude oil prices while causing strength in the dollar, as investors park their funds in the US currency, which is considered a safe-haven asset. High oil prices amid a stronger dollar pose additional risks to India’s current account deficit as well as inflation. Tariff hikes in the US also boost the dollar, making imports more expensive for India.
How do the RBI’s interest rate decisions affect economic growth?
The gross domestic product measures the value of goods and services in a particular year. When companies seek to expand their operations, they usually access credit from financial institutions. Individuals also opt for loans to make purchases of houses, cars, etc. All this demand contributes to economic growth. However, when inflation is high, the RBI seeks to bring it down by raising demand in the economy. It does this by raising interest rates and therefore making it more expensive to access loans. When economic growth needs a boost, the RBI does the opposite by cutting interest rates and making loans cheaper.