During Y V Reddy's tenure as the governor of the Reserve Bank of India, there were clear, publicly aired differences of opinion on key policy matters between the RBI and the finance ministry.
With the appointment of D Subbarao as governor last September, many believed that the relationship would become smoother, given that he had been finance secretary. Also, Mr Chidambaram moved to the home ministry in December.
The expectations about a more harmonious relationship were reinforced by the co-ordination between the monetary and fiscal announcements in December, which complemented and reinforced each other. However, the stress of dealing with the crisis, often with potentially conflicting objectives in front of them, appears to have brought the differences back to the surface.
Speaking at the annual meeting of the Confederation of Indian Industry last week, Dr Subbarao highlighted the emerging conflict between fiscal and monetary measures. He indicated that a further fiscal stimulus would put pressure on credit markets, offsetting the potential benefits from the RBI's own steps to lower the benchmark report rate and infuse more liquidity into the system.
His concerns were borne out by developments in the market for government securities.
The yield on 10-year securities has been climbing in recent weeks and crossed the 7 per cent mark for the second time during March last Thursday, which is when Dr Subbarao delivered his speech. This development is largely attributable to the substantial increase in the quantum of government borrowing, reflecting the surge in the fiscal deficit.
Of course, the RBI has room to accommodate the larger government borrowing, given that the repo rate is still at 5 per cent; the cash reserve ratio too can be lowered further. But the governor is right to be concerned when the political directive is to lower interest rates across the board.
Meanwhile, at the same CII meeting, Montek Ahluwalia, deputy chairman of the Planning Commission, and Arvind Virmani, chief economic advisor in the finance ministry, asserted the need to keep the fiscal stimulus going.
The impact on credit availability was not seen to be oppressive, notwithstanding the recent interest rate movements. Rather, the risks of holding back, given the uncertainty plaguing private spending, were emphasised.
Implicit in this argument is a call for the RBI to fall in line and begin to offset the rise in yields on government securities by further rate cuts and liquidity enhancements, something that the RBI seems to be worried about.
Both viewpoints have merit, given the different objectives and compulsions of each entity. However, investors, companies and consumers waiting anxiously for cohesive and credible policy actions from the government system will be confused by the re-emergence of differences between Mint Road and North Block/Yojana Bhawan.
It is important that all the entities involved come together on the same platform and speak publicly with one voice.
The government, on its part, needs to look at how it can regain control over public finances after the elections, without weakening the impact of the stimulus. The RBI needs to counter the surge in interest rates, while continuing to push banks to increase credit flows to the private sector.
The risks of not sorting out these issues quickly are far too great, because the economy is poised between continuing down the plunging output curve and levelling off because the bottom of the downturn is about to be reached.