As readers of this column know well, I haven?t had much positive to say, in recent years, about the monetary policies of RBI. Central bank policy comes in two areas?exchange rate and interest rates. On both counts, the policy has been mysterious, and questionable. RBI has consistently changed its goalposts regarding inflation, growth, and the tradeoff between growth and inflation. On exchange rates, in my humble view, it has misunderstood the mechanics of exchange rate devaluation.
Currency devaluation does help growth, but a real devaluation can be achieved in one of two ways. The first method is to not allow the currency to appreciate when ?fundamental forces? suggest that it should. These forces come in two forms: excessive capital inflows or higher per capita GDP growth than that of the US (devaluation with strength), and a nominal devaluation. Research shows that the former, productivity-based devaluation, is much more significant than the latter (devaluation from weakness).
In recent years, RBI has done just the opposite of what both theory- and empirical-based evidence would suggest. It has consistently devalued from a position of weakness, rather than a position of strength. Former RBI deputy governor, Dr Rakesh Mohan, forcefully made the same point in a recent interview. So, don?t believe me, but at least believe a distinguished former RBI official. Though former governors Dr Bimal Jalan and Dr YV Reddy have not yet opined on the issue, my guess is that they would agree with Dr Mohan. And if you don?t believe all of these distinguished economists and policymakers, just look at what China has done for the last 30 years.
Regarding that other aspect of monetary policy?setting interest rates?RBI has camouflaged, changed goalposts, spoken with many forked tongues, and has been confusing. It has been relentless in talking about inflationary expectations, something no one can convincingly measure, and least of all by the so-called inflation expectations survey conducted by RBI. Every inflation measure known to woman or RBI is down from its peaks, the core inflation measure of RBI has averaged less than 2.5% for 2012, and the GDP deflator for the January-March quarter registered 3.3%. (All data are SAAR?seasonally adjusted annualised rates).
Not just inflation, but growth has also fallen, and fallen mightily. The once-proud Indian economy is stuttering at sub-par growth. And what did RBI do at its most recent policy review meeting on July 31? It kept the repo rate unchanged at 8%, and threw an inconsequential bone to the growthwallahs by reducing the statutory liquidity ratio (SLR) level from 24% to 23%. Inconsequential because the banks are not finding any borrowers and parking 29% of the funds! The reduction of SLR from 24% to 23% is gratuitous, and meaningless.
Given all these faults, why am I cheering the RBI decision to hold the real repo rate steady at an exorbitantly high 4.7% (repo rate 8% minus 3.3% inflation, GDP deflator)? It is because, unfortunately for India, and RBI, the fiscal policy undertaken by Sonia Gandhi and Pranab Mukherjee over the last several years has been irresponsible beyond compare. One always knew about Ms Gandhi?s populist instincts; in case anyone was in doubt, the former finance minister, Mr Mukherjee, boldly declared in his maiden speech after ascending the stairs of the Presidency: trickle down growth does not help the poor, only government intervention does. Why isn?t the Prime Minister among the fiscally irresponsible decision makers of India? Because one cannot accuse him both of being subservient to the wishes of Madam Gandhi and of making decisions that he has been against throughout his long and distinguished career. I think people do injustice to logic, evidence, and Mr Singh by blaming him for both not making economic decisions and for making these same woefully wrong decisions.
So, what is a central bank to do? As a first measure, it should confront, cajole and coordinate with the fiscal authorities in order that sensible policies for India be followed. There seemed to be very little agreement, and therefore co-ordination, when Mr Mukherjee was the finance minister. But hope did spring eternal when he was promoted to the ceremonial post of President. Then Mr Singh was in charge. Yet, to date, no action has been taken on the reduction of diesel subsidies. Madam Gandhi?s defence is that this will be an unpopular decision. But unpopular for whom? An early lesson I learnt in the study of economics was to ?follow the money??if some decision is not ?rational? then somebody must be making money. The diesel subsidies primarily accrue to the middle class and the rich; there is illegal trafficking in the oil sector. The car companies benefit from the subsidy to diesel cars.
The recent drought has presented the Congress, and Madam Gandhi, with an ideal political recovery path. (If there is someone in worse shape than the economy, it is the Ms Gandhi-led Congress party.) It can outline a path to remove diesel subsidies over the next 12 months in a time-bound manner. With some ?likely? luck, oil prices will move downwards so the overall adjustment may not be as onerous as it looks today. With sensible policies, the rupee will appreciate, and this will further bring down the price adjustment. And Madam Gandhi can state that part of the gains from subsidy reduction will go towards drought relief and will go to the genuinely poor rather than artificially poor supporters and beneficiaries of wrong policies.
RBI is to be applauded for confronting the Centre and standing up to the populist policies reminiscent of the unfortunate economic regime under another female Gandhi. It has not reduced repo rates because the Centre has been arrogant in pursuing fiscally-retrograde policies like high procurement prices for food (hence food inflation and higher food subsidies) and high diesel subsidies (hence higher wasteful expenditure, higher fiscal deficit). It is now show me time?the Centre changes its bad economic policies, or all of India , and especially its poor, pay a heavy economic price of high unemployment, low growth, and high food inflation.
If the Centre acts sensibly and responsibly, RBI will cut rates to further benefit India. But this government has lost all credibility for doing the right thing. RBI is right in calling for action rather than meekly bearing the burden of the piously populist policies of the UPA-2. Laaton ke bhoot baaton se nahin maante.
The author is chairman of Oxus Investments, an emerging market advisory firm. Please visit http://www.oxusinvestments.com for an archive of articles etc; surjit.bhalla@oxusinvestments.com
