As the turmoil in the global financial markets unfolds further, it is becoming increasingly unlikely that India will remain unaffected. As this newspaper has argued for many months now, expectations about the Indian economy decoupling will go the same way that notions about financial and stock market decoupling went. Evidence of sub-prime exposure of Indian banks is only a small part of the story. The main story will be a slowdown in growth as the US economy goes into a recession. Unfortunately, policymakers in India have failed to respond to the writing on the wall. For months it has been clear that there are signs of a slowdown in the Indian economy. However, the RBI did not respond. Today, it is talking about inflation when the biggest threat to the Indian economy is a sharp slowdown. Growth rates of industrial production have now been low for three months in a row.On inflation, the RBI’s policies have not met the challenges that India faces. Two serious policy mistakes have been made. First, while all other currencies of the world appreciated against the US dollar, especially after the sub-prime crisis began in mid-2007, the Indian rupee remained flat between Rs 39 to 40 to the dollar. This was done in response to loud pressure from exporters in April and July. Instead of being forward-looking, the RBI was, as usual, responding late in the day. A pegged rupee in an environment where the dollar was rapidly depreciating against other currencies meant giving up a lever to reduce prices. In the month of February, heavy intervention by the RBI in foreign exchange markets resulted in the rupee depreciating. If the pressure of inflation is high, if all major currencies of the world are appreciating against the dollar, it makes no sense to push the rupee to depreciate.The second serious policy mistake, as this newspaper pointed out earlier, has been high interest rates. With the economy facing a slowdown, it was necessary that the RBI cut interest rates. Now, as the cost of capital is rising, the flat rupee has not been able to push up exports to the extent that industrial growth did not decline. To address the twin questions of low growth and high prices, there should be a policy mix of rupee appreciation and a cut in interest rates. This should be done with great urgency. Not after a slowdown is deep and irreversible. India today desperately needs a central bank leadership that can take initiatives and act proactively.
