In his first policy statement on September 5, the day he was appointed Governor of Reserve Bank of India, Dr Raghuram Rajan outlined his vision for monetary policy. He spoke with considerable confidence about the monetary perils that faced India, high inflation and low growth. Rejecting his own beliefs about the exclusiveness of inflation targeting, Rajan admitted that from India?s and RBI?s vantage point, inflation targeting and growth targeting were twin targets, albeit requiring different weights at different times. This was a dream debut, a century in the very first innings.
On September 20, Rajan came in to bat again. Surprising everyone, he sounded no different from his predecessor Dr D Subbarao, and no different from what the IMF would have said. The fact that he indulged in deep IMF-speak is not necessarily indicative of scoring few runs. After all, it was as an IMF Chief Economist that Raghu was prescient in his forecast that the world economy was heading towards a crisis. But his second innings at the RBI was a dud, as he flailed about scoring (charitably) less than 10 runs. There have been only 17 batsmen in Test history who have scored a debut century and followed it up with a single digit score. Not an auspicious beginning for Dr Rajan; however, in this select club is WG Grace who scored 152 on debut and 9 in the second innings. And the betting should be good that Rajan can be, and likely will be, an economist?s Grace.
There were several inconsistencies that were responsible for Rajan?s low score. What has US tapering or no tapering got to do with Indian inflation, where most of the inflation is due to food, and when most of food inflation emanates from administered minimum support prices? It is true that tapering provides incompetent governments with an excuse for their domestic failures, but for Rajan to offer this excuse was a snick that did not carry. Rajan seemed to be worried about the recent rise in WPI inflation ?as the pass through of fuel price increases has been compounded by the sharp depreciation of the rupee and rising international commodity prices?. There is precious little RBI can do about price increases beyond its control?like domestic food and international commodity prices. And was the depreciation of the rupee to near 70 because of the inevitable possibility of US tapering?
There were other snicks in Rajan?s presentation like the undue haste with which he raised the repo rate by 25 basis points. Just recently, he has argued that interest rate policy is a weak instrument to encourage growth. This might be his view on tapering but good central bankers around the world have consistently believed that both fiscal and monetary policy matter and matter for both growth and inflation. In any case, logical consistency would dictate that a lowering of repo rates is equally ineffective. But lowering repo rates would have helped confidence, and some investment. So why not do it? Given the economic circumstances (see table) Rajan?s attempted drive for applause as an inflation hawk most likely backfired. Rajan could have achieved his goals better with a different emphasis, a different speech, and a slightly different policy. This is what I would have said.
My first task as RBI governor is to help resurrect the Indian economy, to gradually bring it back to its normal and/or potential. While estimates of normality vary, everybody admits that a 4.5% GDP growth is sub-normal, and a 10% inflation level is way above normal. Indeed, one can make a reasoned argument that part of India?s growth problem is the high inflation level. While I do not believe in targeting the exchange rate, it is also the case that many businessmen and economists believe that the rupee at 67 to the dollar (value on my first day as Governor) is unreal.
On July 15, the RBI initiated a series of measures to help contain the rupee to a value below 60. The number one achievement of these measures was to achieve zilch; the number two achievement was to render impotent the repo rate. As you know, these measures were consistent with an alphabet soup?pick any three letters and you will find a policy. MSF, CRR, SLR, LAF, etc?even I don?t remember all the combinations RBI and/or the ministry of finance dreamed up. Most people said on July 16 that these policies would be a failure?and spectacularly fail they did. The rupee went as high as nearly-70, confidence was dented severely, and even less people now believed that the government had any clues about monetary or fiscal policy. What did RBI achieve? A 300 basis point increase in the effective borrowing cost of funds. And this on top of industrial growth which has averaged -3.1%, 2.9% and -3.5% in the last two and a half years!
The first, and most important lesson, of policy making is the following: learn from your mistakes. To make a mistake is human?to continue believing that the mistake was the right thing to do is arrogant stupidity. So my first policy goal is that effective today, we are going back, monetarily speaking, to the world that existed before RBI?s ?night of the long knives?, July 15.
I have been reminded by some that this action would have meant a drastic ?reduction? of borrowing rates. How can interest rates be cut by 300 basis points in one go? The same way they were raised?in one go. A mistake is a mistake. The eventual goal is to have one policy instrument?the repo rate, and a sensible level of the rate. This will take time, but the journey has started.
There is another objection to getting back to July 15, ex ante. It is that given double-digit inflation, shouldn?t interest rates be raised? India?s double-digit level inflation is of paramount concern. CPI inflation averaged 8.4% in 2010. After RBI started tightening policy rates in 2010, CPI inflation has recorded 9%, 9.9% and 12.9% in 2011, 2012 and 2013 (till August). This suggests that the Indian economy is topsy turvy and upside down?RBI raises interest rates and inflation goes up!
We know that killing demand should not mean higher inflation. While food inflation has zoomed up, non-food core inflation has systematically declined?from 9.6% rate in 2011 to 7.6% rate in August, 2013. My dream is to make RBI the number one macro policy research organisation in India (and just like the US Fed). It is high time policy was informed by research, or PIR in short. (No coincidence that pir also means a wise person in Punjabi and Hindi). PIR should emerge as our most effective policy instrument for containing inflation and facilitating growth.
The author is chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Zyfin, a leading financial information company. He can be followed on Twitter,
@surjitbhalla
