Let the rupee go

Okay, reality check: is the world8217;s poorest individual an Indian? After the 61st round of NSS National Sample Survey for 2004-05 became available, it is impossible to argue that poverty hasn8217;t declined, though there are inter-regional variations. It is also impossible to argue employment hasn8217;t increased. Critics of reforms used to earlier talk about jobless growth, preferring growth-less jobs instead. Now they talk about quality of employment.

A day before the mid-term review, RBI8217;s take on this embarrassment of riches was: high real GDP growth; manufacturing doing well for April-August 2007, but some slowdown; services doing well; barring electricity, infrastructure not doing that well; tax revenue buoyant; inflation under control because of 8220;pre-emptive monetary measures since mid-2004 accompanied by fiscal and supply-side measures8221;; crude oil prices up to 89.5 a barrel; slowdown in growth of merchandise exports, but large net invisibles surplus and large FDI 6.6 billion from April to July and FII 21.2 billion from April to October 19, 2007 inflows. One can8217;t disagree with this, except on inflation.

We have inflation rates of 3.07 per cent via the wholesale price index WPI, week ending October 13; 7.26 per cent via the consumer price index CPI for industrial workers, August; 7.89 per cent via the CPI for agricultural labourers, September; 7.61 per cent via CPI for rural labourers, September; and 5.7 per cent via CPI for urban non-manual employees, September. As a statistical point, these trends vary because baskets and weights differ, as do points of collecting price data. Having said that, it is impossible to argue that 8216;pre-emptive monetary policy8217; has had much to do with reducing WPI-based inflation, or can have much to do with reducing CPI-based inflation. RBI has of course hedged by bunging in 8216;fiscal and supply-side measures8217;, which can cover everything else under the sun.

I haven8217;t been able to track down who first used the expression 8216;pre-emptive8217; in a monetary policy context. Pre-emptive action means action taken as a preventive or deterrent measure, often in a war context. I wonder how many people in RBI play bridge, because in that context, a pre-emptive bid has a specific nuance. It is a bid when one has very few high card points and wants to disrupt communication between opponents. RBI has almost no high card points in determining monetary policy.

We shouldn8217;t forget the Foreign Exchange Regulation Act FERA yet. The second half of the Preamble to FERA 1973 said this was legislation 8220;for the conservation of the foreign exchange resources of the country and the proper utilisation thereof in the interest of the economic development of the country8221;. Given our foreign exchange reserves, all that has changed is that instead of conserving foreign exchange resources, the central bank now conserves the exchange rate. If an economy does well, as India8217;s is, one can8217;t prevent currency appreciation.

Moses kept telling the Pharaoh 8220;let my people go8221; and when the Pharaoh didn8217;t listen, Egypt was visited with ten plagues. Not letting the rupee go is not without its plagues. Not only have economies done well when currency appreciates, the Chinese example notwithstanding, it is impossible to maintain under-valuation when capital flows aren8217;t restricted. RBI highlights rupee appreciation against US dollar, euro, pound and yen, especially the first. What is important is not just these currencies, but others too, and the real exchange rate, not the nominal one. Once one does that, depending on the index used, evidence on rupee appreciation is much more suspect.

But we will not allow the exchange rate to be completely determined in the market and will mess around with market forces. Apart from everything else, exporters and the commerce ministry will scream blue murder and we also have this notion about separating speculation-driven volatility from secular trends. So fix some arbitrary rupee/ dollar rate, perhaps allowing for appreciation of 10 paise a month or something like that and buy up dollars to preserve that reference rate.

Other than the sub-optimal excessive reserve problem, this fuels liquidity. Hence the need for hardening rates and mopping up liquidity through CRR increases, since sterilisation doesn8217;t work. To justify this, one may as well invoke the inflation spectre by citing high CPI-based inflation and the unlikely eventuality of higher domestic petroleum prices materialising, particularly because earlier interest rate hikes don8217;t seem to have hurt industry or investments that much. However, goods exports have been hit by rupee appreciation. This is the background to the half-yearly review of monetary policy.

In all fairness, no one expected RBI to slash rates bank, repo, reverse repo yet. However, was there a need to hike CRR to 7.5 per cent? When the UPA government took over, CRR was 4.5 per cent. Indirectly, CRR hikes prevent commercial banks from reducing lending rates.

Since 1991, RBI has been adroit at managing forex shortages and crises. However, RBI8217;s monetary policy still hasn8217;t figured out how to manage foreign exchange surpluses. To compound the problem, other central banks have slashed policy rates some have increased them too. But linked as we are to the dollar and the US economy, what happens if Federal Reserve cuts rates further? The capital inflow conundrum will worsen. And RBI8217;s monetary policy will continue to remain a square peg in a round hole.

The writer is noted economist