Goalposts shifted,RBI scores self-goals

From WPI to core inflation to CPI,RBI shuffles what it measures and even concludes interest rates don’t affect investments

Written by Surjit S Bhalla | Published: June 20, 2012 3:24 am

And if you can’t find supporting data,RBI;/ Invent the one you want,and love the one you invent.

(With apologies to Stephen Stills,“Love the One You’re With”).

The RBI kept interest rates close to the highest levels in modern Indian history on June 18. On cue,this quixotic policy was met by a chorus of support from the Sancho Panzas waiting in the wings. This shows that the RBI is independent,that Governor D. Subbarao did not give in to pressure,that he is continuing the good fight against inflation,and without much sacrifice against growth. Don’t be surprised if in the next few weeks Subbarao is compared to his mentor,C. Rangarajan,and both are compared to US Fed Chairman Paul Volcker’s hugely successful fight against inflation in the early 1980s.

But before this comparison takes on mythical and mystical proportions,some ground realities. The table shows the performance of the three central bank governors at the time they took on the battle against inflation. It is a no contest,and not even by a wide margin. During Volcker’s tenure,the fed funds rate averaged as high as 16 per cent in 1981,but he had something to show for the sacrifice. Within one year of this rate hike,inflation collapsed to single digits in 1982,and to about half the magnitude of the previous two years,6.2 per cent. A year later,the recession was over and growth rebounded to an average of above 5 per cent for three years,1983 to 1985. History has correctly evaluated Volcker as one of the finest central bankers,ever.

The two Indian central bankers fail in the comparison. There was hardly any decline in inflation in India during 1994-1998,at the time Rangarajan embarked on his inflation-fighting strategy. In contrast,the median developing country CPI inflation declined by six percentage points between 1994 and 1998! However,GDP deflator inflation (not shown) did reduce by about 2 percentage points,1996 to 1998. What happened to growth? It also declined by 2 percentage points to 5.1 per cent,1997 to 1998,from a then historic high average three-year growth of 7.1 per cent.

Subbarao’s tenure isn’t much better than Rangarajan’s,and perhaps is much worse. Inflation in 2011 was the same as in 2009,and unlike the prior decade,domestic inflation is about 5 percentage points per year higher than comparator inflation. This persistently and abnormally high inflation has little to do with monetary policy and everything to do with the populist agricultural policies of the kulak-oriented UPA,led by socialist supremo Sonia Gandhi and the National Advisory Council. So one cannot,and should not,blame the RBI for the high food inflation induced by high procurement prices given to the rich kulaks of India (in the UPA’s prose,the aam farmers).

But one should blame the RBI for being naively quixotic in its pursuit of reducing administered price inflation by killing the economy. The data abundantly reinforce this point. The average repo rate has gone up by 350 basis points since 2009,and CPI inflation has stayed constant,food inflation risen enormously,and GDP growth has collapsed by 3 percentage points. The GDP price deflator in the last six months has averaged 7.3 per cent,only marginally higher than the 2009 average.

Why has the RBI been so wrong,at least in outcomes? Perusal of the most recent policy statement suggests that the RBI has a very different model of the economy,a model it should review for insights into its (lack of) performance. Shockingly,the RBI makes a categorical statement that investment is not affected much by interest rates; “the role of interest rates is relatively small” it concludes,without offering any evidence whatsoever. This is news to all economists,and central bank governors,defunct or otherwise.

The Subbarao-led central bank has to be congratulated for being more open than its predecessors. But this openness comes at a huge cost — it is accompanied by a persistent habit of constantly changing the goal posts of analysis — hence,the quote at the beginning. Sometimes it is growth,sometimes inflation,sometimes core inflation,sometimes fiscal deficits. Worse,the evidence it offers in support of its policy is,at a minimum,debatable,and at a maximum,questionable.

Two examples of this less-than-casual empiricism. “Estimates suggest that real effective bank lending rates,though positive,remain comparatively lower than the levels seen during the high growth phase of 2003-2008”. I presume the RBI means 2003 to 2007 because 2008-09 was the Lehman year,and most emphatically not a high growth year! During this period,nominal SBI prime lending rate averaged 11.5 per cent,and GDP deflator inflation (less prone to sampling errors and considerably more comprehensive than the CPI) averaged 5 per cent,for a real rate of 6.5 per cent. The 12-month GDP deflator was 6.7 per cent in January-March 2012. The SBI prime lending rate — 13.75 per cent. Real rate — 7.25 per cent. If the ICICI Bank benchmark advance rate of 18.5 per cent is taken,the real rate is a whopping 12 per cent.

The RBI also errs in its interpretation that the devaluation has added much to India’s competitiveness. (A detailed analysis in the next article.) All that has happened is that the devaluation has just about made up for the loss in competitiveness due to the high inflation years of 2008 to 2011. One way to look at the data is that competitiveness is back to the levels prevailing in 2007,and the cost of capital is 3 percentage points higher,and inflation about the same,and growth some 4 percentage points lower. Not a pretty outcome for an independent central bank.

The writer is chairman of Oxus Investments,an emerging market advisory firm

For all the latest Opinion News, download Indian Express App

    Live Cricket Scores & Results