Raghuram Rajan seems to have taken the side of inflation in the controlling inflation versus slowing growth debate. In a speech to the Research and Analysis Wing (RAW) he said (ET):

"Inflation is a destructive disease. Industrialists complain about high interest rate but we don’t have a choice but to keep interest at high rate because inflation is high at 8 per cent."

“While industrialists want an interest rate of about 5 per cent, a citizen would like the saving interest rate to be 10 per cent. The mismatch between industrialists demand and account holders is because of inflation.”

"The point is inflation is hitting the growth in the long run. There can be no trade-off. There is need to bring inflation down. Can we get inflation under control and get high growth," he said.

This is very good news.

Bringing inflation under control – and especially sustained inflation like we’ve seen recently – is very important. Bringing it under control will hugely help growth in the longer term; right now we expect inflation to be high, and thus demand 10% raises in everything (salaries, budgets, school fees, rents). To get high growth, you have to reduce these expectations to say 2% – then, you have a much better picture of how your costs will grow, and therefore you can plan to produce and sell more to earn more instead of depending on price hikes to customers. That is real growth.

Rajan might just be a Volcker – and I’ve said he isn’t. If he is, I’ll eat my virtual words.

Have you noticed that inflation has moved on from the primaries to the secondaries? The chicken that used to cost Rs. 100 per kg went to Rs. 230 per kg. Chicken secondaries – pre-cooked kababs and sausages and all that – went from Rs. 160 per 500g to, now, Rs. 200, and those prices haven’t come down. Restaurants have increased menu charges. People pay Rs. 12 to Rs. 14 for a coffee in Bangalore, which used to be Rs. 10 in 2012, at the low-cost darshini. These secondaries don’t come down. Restaurants don’t cut menu costs – they would rather go out of business. Inflation in the secondaries is particularly harmful.

What we have to do is not just to raise rates but to curb liquidity as well. We should not do any more OMO purchases of government bonds – short term repos to help liquidity are sufficient. The banks just pulled a fast one on RBI – after borrowing big on MSF last friday, the RBI was spooked enough to announce a 28 day term repo on Tuesday, of Rs. 20,000 cr. – and that went at a very low 8.15% (if there was liquidity pressure it should have gone at 8.75%, the MSF rate). We also had on OMO bond repurchase on Wednesday, at aggressively low rates, of Rs. 10,000 cr. All this liquidity will only push inflation higher in the longer term – though it should be noted that repo has to be returned within a month, but OMO liquidity is permanent (and should have been avoided, IMHO).

Once we choose what we have to fight (inflation or slowing growth), we can choose the weapons (liquidity, interest rates). At this point, I’m happy that the target is getting less and less ambiguous, and the RBI is in favour of first fighting inflation.

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