No proof required: Leave your ego at home

No proof required: Leave your ego at home

Average CPI inflation for eight months since September 2016 has been 3.7 per cent. How long are you going to wait and watch, MPC, before you admit that you were wrong in your assessment?

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Illustration by C R Sasikumar

Times have changed, and we have to change accordingly. It wasn’t so long ago that the central concern of the RBI, and the major macroeconomic concern in India, was inflation. Ask the Congress why they lost the election or why Modi won it; high inflation was a major factor. Today, equivalently, high real interest rates are the major impediment to Prime Minister Modi’s goal of achieving reasonable GDP growth and the jobs that come with it.

The major impediment to the creation of jobs in India — the refusal of the RBI and the MPC to acknowledge that they have erred, and erred badly, in taking real rates in India to the highest level in 16 years.

For armchair policymakers like myself, it was easier in the pre-MPC days. There was only one person, the governor, to blame or give credit to. But what are we expected to do now? Blame a committee which is confounding everybody with its no-policy policy of keeping real repo-rates the highest among major economies in the world (excluding Brazil and Russia).

I wish to break with the past, and polite anonymity; I intend to discuss policy and names associated with specific policy recommendations. I have known many of you (MPC members) for the last 20-odd years, and so I am certain the analysis, and criticism, will be taken in the right spirit.


The MPC should remember that it is an inflation-targeting institution — its members are supposed to know more than most mortals about the past, present, and likely future behaviour of inflation. By its own admission, this has not come to pass. One of the more productive paths the MPC could take is to produce a White Paper on what went wrong.

How many central banks do you know, or have come across, who have made official forecast errors of inflation as large as you have? Don’t bother to Google — none. In December, you felt March CPI inflation would be 5 per cent with an upside bias. In April 2017, one MPC member (Patra) felt that the MPC should hike rates to prevent future inflation, which came out at 1.5 per cent, a 15-year low, just three months later (June CPI).

Chetan Ghate: In October 2016, you voted to reduce the policy rate from 6.5 to 6.25 per cent. The last three inflation rates you saw were 5 per cent, 6.1 per cent and 5.8 per cent. Yet you voted for a rate cut stating that there were acceptable risks to inflation. In June 2017, the last three inflation rates you witnessed were 3, 3.9 and 3.7 per cent. A week later, the May CPI inflation came in at a 15 year low of 2.2 per cent. Yet, you felt the repo rate could not be cut, because it would be “prudent to wait and watch”, a sentiment also echoed by all but one member of the MPC.

Pami Dua: You, like others in the MPC, keep citing the “fact” that the US Fed is going to raise interest rates, and therefore, Indian rates should stay high. Europe and US policy rates will rise but no macro-theory, or evidence, tells us that Indian rates cannot simultaneously fall. Monetary policy and inflation targeting are about real rates; what is expected from the MPC is that when inflation falls, policy rates also fall and not what the nominal policy rate in the US is doing. And please stop citing the ECRI (what does it stand for?) as the authority on Indian inflation trends. You are the authority — so cite your own research.

Ravindra Dholakia: You have been very right about the great inflation decline. My only criticism is that you came late to the party, but I appreciate the fact that you operate in a feudal Indian set-up like the RBI. I know, from personal experience, having written two dissent notes for the RBI Committees on Capital Account Convertibility.

Michael Patra: In October 2016, you stated that you, and the MPC, felt that the real policy interest rate in India was no longer 1.75 per cent (between 1.5 and 2 per cent) but rather 50 bp lower at 1.25 per cent. This “realisation” was needed because with the last (August 2016) inflation reading of 5 per cent, the policy rate in October could not be reduced with a real rate of 1.75 per cent. By the October MPC logic, and application, the real policy rate in India today is 4.75 per cent, the highest in 15 years, and in need of a rate-cut of 325 bp. And incidentally, the RBI (and Raghuram Rajan) were wrong, quite wrong, when he stated that the comparable real policy rate (of other emerging markets) was between 1.5 and 2 per cent. Even at that time (December 2014, in an interview with Prannoy Roy), the median real policy rate in major developing economies was less than 1 per cent — and even lower today.

Viral Acharya: You are right in stating that the number one priority for the RBI is the solving of the NPA problem. But as an MPC member, your number one priority is inflation and the setting of appropriate real rates. The refrain of most apologists for the strange goings-on at the MPC is that deeply indebted corporates will not be helped by interest rate cuts of 25 bp or even 250 bp. But what mandate of the RBI, or MPC, states that deeply indebted corporates are the only concern? Are there no other borrowers in the system? Is the MPC setting rates for only the suit-boot types? Is the MPC the real suit-boot ki sarkar, and if so, will you please stand up and say so? The nation wants to know.

Urjit Patel: I don’t envy you — being governor of the RBI at such a transformative time is very challenging. Watching a historic inflation decline (greater than any other non-hyper inflation economy since the early 1980s), demonetisation, stressed bank assets etc. You also have a strong belief that fiscal deficits matter for inflation. Hence, fiscal deficits are high, and the RBI cannot cut rates. But why did you vote for a cut in October 2016? And you must know that while fiscal rates (centre plus state) were the highest in India for the seven years 1999 to 2005, Indian CPI inflation averaged 4.1 per cent. There maybe an explanation (not much but here is a try) for why the MPC has been so wrong and for so long. It is because they have been market theorists, not market practitioners. I have always felt that it is important that financial market regulators and researchers spend some time in the “market” before they make policy for other mortals.

The reason is simple — in one of many split seconds, every day, you are proven wrong by the market. There are several important things that the market teaches you, and teachings that are not easily replicated elsewhere. For example, humility, an attribute all too missing among many policymakers and academics, and not just those at the RBI or MPC. Humbled by forecasts being wrong, by analysis being right but the interpretation being wrong. The beauty of the market is that it is autonomous, and unlike Facebook or Twitter, you pay with your losses for the experience, and knowledge.

Related to humility is possibly the biggest lesson learnt from the market — the ability to look yourself in the mirror, and others in the eye, and say, yes, I was wrong. This is one reason left-oriented intellectuals do not believe in the market — it can hurt them, really hurt them, for their belief in false opinions, and even more false gods. Much better to be in the safety of one’s opinions, and being wrong for the wrong reasons.

The beauty is that if I am proven wrong, I have less ego, and certainly zero ego in making financial decisions. Market participants may be the most egotistical individuals on earth, but they leave their ego at home, where it belongs. Which is why they are not so blinded by the Great Inflation Rate Decline that they refuse to see.


The writer is contributing editor, ‘The Indian Express’, and senior India analyst at Observatory Group, a New York-based macro policy advisory group. Views are personal