RBI worsens the UPA blow

If UPA’s populism wasn’t bad enough,RBI’s misguided interest rate policy finished off what growth was left

Written by Surjit S Bhalla | Published: June 2, 2012 3:12 am

If UPA’s populism wasn’t bad enough,RBI’s misguided interest rate policy finished off what growth was left

You raise rates galore,and what do you get,

The economy weaker and deeper in debt,

I am the RBI and I will do more,

Because I owe my soul to the monetarist store.

(With apologies to Tennessee Ernie Ford,‘16 tons’)

Worst GDP growth (5.3 per cent,year-on-year) in nine years. Worst manufacturing growth,-0.5 per cent,in 14 years. The analysis has followed and the conclusion is brutal,and correct. The UPA government has led the Indian economy to near destruction. Most of the correct explanations for the collapse of the Indian economy centre on the wildly socialist policies of Sonia Gandhi,Manmohan Singh and Pranab Mukherjee.

Some of these three esteemed leaders are known for their brilliance in strategic political leadership. If so,the question needs to be asked: how come the Congress party has lost nearly every election it has fought since 2009,and that too by humiliating margins? In normal political parties,such leaders would be thrown out ignominiously,but the Congress is made of sterner stuff. Some of these leaders are known for their economic expertise. If so,this “in the name of the poor” economics is no longer suitable for the Indian poor or any economy in the world. And some of these leaders are known for management of committees,allies,policies and the economy. But can anybody point to one committee that has succeeded in making a decision,or one political ally who is satisfied,or one good economic policy that this government has introduced? No,but the three leaders are all there,mismanaging the economy to destruction.

The GDP data that came out refers to the fiscal year 2011-12,a period ending in March 2012. The worst ever Indian budget was presented by Mukherjee on March 16,a budget that soured the economic scene by the introduction of retrograde taxation schemes and by a bad business-as-usual approach to economic policy. Some analysts are attributing the precipitous decline in GDP growth to the precipitous decline in investment sentiment caused by Budget 2012-13. One can blame Mukherjee for a lot of bad policies,and one should,but one cannot blame his 2012-13 budget for the GDP decline in the previous year,2011-12.

So what did cause the decline in GDP growth into unchartered territory? Clearly the spend as spend can policies did not help. And the RBI has been correct in pointing out the flaws inherent in the wasteful deficit policies at the Centre. But I believe the RBI (and its legion of like-minded followers in the investment banks) has erred,and erred grievously,in its interpretation of the causes of inflation. This error in interpretation has also led it to pursue a pro-cyclical interest rate policy,the most grievous of all errors a central banker can make. This is expanded on below,and in a follow up article next week

The high rates of inflation in India since 2007 are due to the expansive and populist policies at the Centre. These policies have involved subsidies to farmers in the form of high procurement prices for food. How can an increase in repo rates help bring down food prices when most of these prices are administered? Rice producers in India were paid nearly the highest price for their product in 2011-12,and yet India was the largest exporter of rice. How was that possible? It was possible because the domestic market price of rice was considerably below this high price given to selected farmers. What was not sold to the government was exported; and what was sold to the government at super high prices was allowed to rot because the government did not have enough storage space! And we have the Commission for Agricultural Costs and Prices (CACP) clamouring for radical increases in procurement prices. Can the RBI communicate,inter-governmentally,with those responsible for food inflation,please? This will make for better agricultural policy,a better fight against inflation,and a better interest rate policy on growth.

The RBI has had an ever-changing story on inflation. At its convenience,it invokes inflationary expectations,a virtual number based on an actual survey. This survey regurgitates inflation at the wholesale price level with great accuracy,so the RBI should decide to join the austerity drive at the Centre (for example,ban on five-star hotel lunches) and junk its expensively useless inflation expectations survey. The RBI has also introduced innovative explanations for the high inflation wrought by high administered prices. The one I like the most is that food inflation is high because our food consumption pattern has radically changed towards protein consumption. Now protein consumption has been around in all countries for the last 3,000 years,and it does increase with income (potatoes to meat) but that it causes an increase in the inflation rate is a unique contribution to our understanding. Almost as innovative is the explanation that India has high overall inflation because its growth rate is higher than other countries; now presumably,since our growth rate has collapsed,we will have low overall inflation? But will we,given this largesse of UPA 2? And what happens to overall inflation if the CACP has its way with increasing procurement prices for the most highly compensated paddy producers in the world?

Somewhere along the way the RBI realised that it had gone wrong and started emphasising core inflation. It defined core inflation to be inflation originating in the non-food manufacturing sector. Reasonably correct. But its urge to be innovative persisted. It now contended that the core inflation of 7-8 per cent was indicative of “pricing power” on the part of manufacturers. Can there be any pricing power in freely traded goods? No. In such an instance,far from pricing power,output prices rising at a persistently lower rate than input prices is indicative of the shortest route to bankruptcy — or a negative growth in manufacturing which the RBI’s policies have now achieved.

Part 2 of the analysis exploring the RBI’s contribution to India’s descent will be presented next week. This article will document how the interest rate hikes of the RBI in 2011 were not only excessive,but also ill-timed; and also why the next move of the RBI in mid-June should be towards an additional cut in interest rates.

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

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