Keep your powder dry, Guv!

Finance minister Pranab Mukherjee is a lucky man. If all goes well, in little over a month from now, he will be comfortably ensconced in the peaceful environs of Rashtrapati Bhavan. Distance-wise he may be only a stone's throw from his former office. But figuratively speaking, he couldn't be further removed from North Block and the cup of woes that comes with being in charge of the finance ministry when the economy is tanking.

The Reserve Bank of India (RBI) governor, poor man, is not half as lucky. Subbarao has another 15 months to go before his term comes to an end in September 2013. So, he will have to soldier on even as problems on the economic front become more intractable and the government, in the run up to the next general elections, becomes more irresponsible on the fiscal front. Unlike Pranab da who only has to bide his time, ' apres moi, le deluge' (after me, the deluge), the governor will have to face the consequences of whatever he does today.

If he keeps policy rates unchanged and the economy goes from bad to worse, he will be pilloried for it to the end of his term. Even beyond, perhaps! If, on the other hand, he lowers policy rates in response to the clamour from industry chambers, backed by a 'nod and a wink' from finance minister downwards, and inflation picks up momentum, he will not be forgiven by 1.2 billion Indians. There are few things the public is more unforgiving of than high inflation.

That is not all. If household savings dip in response to negative real rates of interest, and it is a no-brainer that they will, investment will be a hit. At a time when investment activity in the economy is already low - the output of capital goods was down 16% in April 2012 - any further decline will bring what remains of the fast-fading Brics story crashing down.

To put that in a nutshell, the governor is in a bind. His choices are constrained by two additional factors: one, poor quality of key data that is an input in any decision the central bank takes, and, two, a government that not only does not play ball, but worse, does everything possible to make the RBI's task more difficult.

Monetary and fiscal policies are like the two arms of a country's macroeconomic policy lever. If one does not work, the other has to make up for the slack. An overly loose fiscal policy, as in India today with the Centre's fiscal deficit close to 6% and likely to go well beyond, means monetary policy cannot afford to be loose.

There is the additional hazard that just two months ago, the RBI had declared that despite decline in growth, there is not "much room for monetary policy easing without aggravating inflation". Any reversal in its stance could further damage a credibility that has already taken a beating.

Yes, one could argue that growth has fallen more than anticipated as evidenced by the poor GDP growth number of 5.3% in the last quarter of 2011-12. That damage to credibility is a small price to pay if it means revival of growth. But if growth has fallen more than anticipated, inflation has risen more than anticipated. Factor in the element of suppressed inflation on account of administered, or unadjusted, prices of diesel, LPG, kerosene, coal and electricity and consumer price inflation is well above 10%.

So what should the governor do? Given that in April 2012, the RBI had affirmed that the "conduct of monetary policy will continue to condition and contain the perception of inflation in the range of 4.0-4.5%", there is one thing he can, and should, do: keep his powder dry, for now.

He's already been told by one commentator that the RBI is not in a popularity contest and, hence, should not bow to popular, but unwise, demands. A view that is strongly endorsed by this columnist. But this does not find favour with many who labour under a fundamental misconception that all it takes to kick-start the sputtering economy is to cut interest rates. If that were the case, the Japanese economy would be firing on all cylinders as interest rates have been close to zero for more than a decade now.

In truth, growth is much more complex. Yet, ignorance persists. A respected business newspaper has called for a 'slashing' of policy rates, urging a 2-3% cut in response to RBI's plain-speaking deputy governor K C Chakrabarty, pointing out that a 1% cut in repo rate will not help.

He is right. Else, the larger-than-expected (warranted?) cut of 50 basis points in April 2012 should have elicited a prompt response from industry. Instead, industrial activity has slowed to a crawl, suggesting there are other factors beyond interest rates that are holding back growth; factors that lie squarely in the government's domain. In such a scenario, trying to boost demand via interest-rate cuts rather than working on increasing supply will only worsen inflationary pressures in the near term.

The economy has lived too long on steroids. Now, when it is showing withdrawal symptoms and there are other complications to boot, another dose will only do more long-term damage.