Opinion In defence of RBI

In recent years,the RBI has done just the opposite of what both theory and empirical evidence would suggest. It has consistently devalued from a position of weakness rather than from a position of strength. Former RBI deputy governor,Rakesh Mohan,has forcefully made the same point in a recent interview. So don’t believe me,but at least believe a distinguished former RBI official. Though former governors Bimal Jalan and Y.V. Reddy have not yet opined on the issue,my guess is that they would agree with Mohan. And if you don’t believe all of these distinguished economists and policymakers,just look at what China has done for the last 30 years.

Regarding that other aspect of monetary policy — setting interest rates — the RBI has camouflaged,changed goalposts,spoken with many forked tongues,and has been confusing. It has been relentless in talking about inflationary expectations,something no one can convincingly measure,least of all by the so-called inflation expectations survey conducted by the RBI. Every inflation measure known to woman or the RBI is down from its peaks,the core inflation measure of the RBI has averaged less than 2.5 per cent for 2012,and the GDP deflator for the January-March quarter registered 3.3 per cent. (All data are SAAR — seasonally adjusted annualised rates.)

Not just inflation,but growth,has also fallen,and fallen mightily. The once proud Indian economy is stuttering at sub-par growth. And what did the RBI do at its most recent policy review meeting on July 31? It kept the repo rate unchanged at 8 per cent,and threw an inconsequential bone to the growthwallahs by reducing the statutory liquidity ratio level from 24 per cent to 23 per cent. Inconsequential because the banks are not finding any borrowers and parking 29 per cent of the funds! The reduction of the SLR from 24 to 23 per cent is gratuitous,and meaningless.

Given all these faults,why am I cheering the RBI decision to hold the real repo rate steady at an exorbitantly high 4.7 per cent (repo rate at 8 per cent minus 3.3 per cent inflation,GDP deflator)? It is because,unfortunately for India,and the RBI,the fiscal policy undertaken by Sonia Gandhi and Pranab Mukherjee over the last several years has been irresponsible beyond compare. One always knew about Sonia Gandhi’s populist instincts; in case anyone was in doubt,the former finance minister,Mukherjee,boldly declared in his maiden speech after ascending the stairs of the presidency: trickle down growth does not help the poor,only government intervention does. Why isn’t the prime minister among the fiscally irresponsible decision-makers of India? Because one cannot accuse him of both being subservient to the wishes of Madam Gandhi and making decisions that he has been against throughout his long and distinguished career. I think people do injustice to logic,evidence and Singh by blaming him for both not making economic decisions and making these same woefully wrong decisions.

So what is a central bank to do? As a first measure,it should confront,cajole and coordinate with the fiscal authorities in order that sensible policies for India be followed. There seemed to be very little agreement,and therefore coordination,when Mukherjee was the FM. But hope did spring eternal when he was promoted to the ceremonial post of president. Then Singh was in charge. Yet,to date,no action has been taken on the reduction of diesel subsidies. Madam Gandhi’s defence is that this will be an unpopular decision. But unpopular for whom? An early lesson I learnt in the study of economics was to “follow the money” — if some decision is not “rational” then somebody must be making money. The diesel subsidies primarily accrue to the middle class and the rich; there is illegal trafficking in the oil sector. The car companies benefit from the subsidy to diesel cars.

The recent drought has presented the Congress,and Madam Gandhi,with an ideal political recovery path. (If there is someone in worse shape than the economy,it is the Sonia Gandhi-led Congress party). It can outline a path to remove diesel subsidies over the next 12 months in a time-bound manner. With some “likely” luck,oil prices will move downwards so the overall adjustment may not be as onerous as it looks today. With sensible policies,the rupee will appreciate,and this will further bring down the price adjustment. And Madam Gandhi can state that part of the gains from subsidy reduction will go towards drought relief and to the genuinely poor rather than the artificially poor supporters and beneficiaries of wrong policies.

The RBI is to be applauded for confronting the Centre and standing up to the populist policies reminiscent of the unfortunate economic regime under another Gandhi. It has not reduced repo rates because the Centre has been arrogant in pursuing fiscally retrograde policies like high procurement prices for food (hence food inflation and higher food subsidies) and high diesel subsidies (hence higher wasteful expenditure,higher fiscal deficit). It is now show-me time — the Centre changes its bad economic policies,or all of India,and especially its poor,pay a heavy economic price of high unemployment,low growth,and high food inflation.

If the Centre acts sensibly and responsibly,the RBI will cut rates to further benefit India. But this government has lost all credibility for doing the right thing. The RBI is right in calling for action rather than meekly bearing the burden of the piously populist policies of UPA 2. Laaton ke bhoot baaton se nahin maante.

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