This time, MP does not mean Member of Parliament, but monetary policy. What I want to discuss today is the fog surrounding monetary policy in India. It used to be the case, around the world, that a deliberate fog was created around central bank speak. That changed post the 2008 financial crisis. Central banks around the world went for the three Cs — clarity and consistency in communication. To a C, all advanced country central banks go for the 3Cs. Among emerging economies I do not know, but what I hear foreign investors say is the developing world is much closer to the advanced economies than to India.
Is India as different as claimed by “experts”? My own experience, and interpretation, is that India is very different because the experts (perhaps including those at the central bank) look at monetary policy very differently. Most importantly, Indian experts look at the monetary policy through nominal lenses; economics is about the real world. After all, nobody talks about nominal GDP growth; when we discuss growth, it is growth adjusted for inflation. Why don’t we do the same with the monetary policy variable called the repo rate — or talk of real borrowing and lending rates?
On August 7, the RBI/MPC reduced the repo rate by 35 bp to 5.4 per cent. The first publication to be off to the races was Bloomberg Quintwhich headlined its story “35 Basis Point Cut Takes RBI Rate To 2010 Level”. The story was accurate. In April 2010, the RBI raised the repo rate to 5.25 per cent. CPI inflation at that time was 13.3 per cent, WPI inflation was 10.5 per cent, and the SBI lending rate was 11.8 per cent. IIP (Index of Industrial Production) was growing at 13 per cent.
It certainly doesn’t take a weatherman economist to figure out that the repo rate of 5.4 per cent in August 2019 is not even on the same planet as April 2010, let alone be uttered in the same line. But I want to quote you from some of the editorials after the RBI move. Business Standard opined that “the central bank is doing its part by progressively reducing the cost of money” (emphasis added). An editorial in Mintargued that what the RBI/MPC did was “the best it could have done under the circumstances, grim as they are”. It also quoted the RBI governor, Shaktikanta Das as stating that the committee felt that “25 bp would have been inadequate, while 50 bp would have been excessive”. And why didn’t the RBI undertake a larger cut? The Mint view: “Because it did not want to send out a panic signal by easing monetary conditions too much, too fast”.
The MPC action (inaction) came against a backdrop of central banks around the world sending out a panic signal by cutting lending rates. But to continue with the editorials. The Financial Express headlined its editorial, “RBI is doing its bit, over to government now”. There is elaboration a few lines down. “But the central bank can only do so much. Indeed, it is doing more than its best to create a conducive lending environment for banks”. The Economic Times editorial said, “Slashing rates by 35 bp, dumping multiples of 25 bps as the quantum of rate change, signals non-routine concern over growth, as also restraint to avert any panic. It also signals RBI’s capacity to go beyond convention” (emphasis added).
There is a surprising uniformity in the editorials — in addition to the fact that they have got the simple fact of cost of money grotesquely wrong. If I were Governor Das, I would be worried. After every budget, the industry bodies gives a strong heads up to whatever fiscal policy package the government comes up with. Out of 10, the ranking is always — good, bad and ugly budgets, the same — a robust 9. A lot of us (including the pink newspapers) have criticised this hypocrisy and this “Big Brother is watching” fear. This lack of objective analysis is worrisome. But why no objective analysis of RBI/MPC actions on the part of the sheep newspapers?
What could the editorials have said? They could have pointed out that inflation is phenomenally low, and below the notional 4 per cent target for now the third successive year. (How many chickens need to cross the road before one concludes that they have crossed the road?) While the nominal repo rate is the same as 2010, the real repo rate is at 2.6 per cent compared to minus 8.1 per cent in April 2010. Stated differently and equivalently, the cost of capital (repo rate) today is nearly 11 percentage points (ppt) higher. SBI lent money then at 11.75 per cent — today, the nominal lending rate of SBI is higher (with much lower inflation) by 2 ppt at 13.75 per cent.
The system is broke, including the experts who report on the system. The same experts blamed the lack of liquidity for the economic slowdown, not the high real rates. Everyone was shouting lack of liquidity as the cause for slow and declining growth in 2018. With this expertly felt lack of liquidity in 2018, industrial production growth Jan-May 2018 averaged 5.4 per cent. With ample liquidity (and all the papers quoted above congratulated the RBI for successfully introducing the much needed liquidity in 2019), IIP growth has averaged 1.9 per cent in 2019. The first five months of 2010 IIP growth averaged 11.9 per cent. But wait a minute — weren’t we coming out of the 2008 financial crisis and that is why IIP was so high in 2010 and not because of real interest rates? There is partial truth in that.
Let us compare first five months of 2011 with 2019. Industrial production growth then was 6.8 per cent; today it is at 1.6 per cent. Real repo rate then minus 2.8 per cent, today plus 3.4 per cent. Real SBI lending rate then 3.6 per cent; today 11 per cent. Liquidity then, ample; liquidity today, ample.
Das took over as governor in December 2018. He has been in office for only eight months and it is unfair to assess any performance on so short a time period. Nevertheless, few facts are relevant. Eight months prior to Das’s arrival, inflation had averaged 3.9 per cent, repo rate averaged 6.3 and the real repo rate averaged 2.4 per cent. Over the last eight (Das) months, (till July 2019) inflation has averaged 110 bp lower 2.8 per cent; the repo rate has averaged 20 bp lower at 6.1 per cent, and the real repo rate 90 bp higher. I forgot to add — liquidity very stressed in 2018 (according to many experts, that was the cause for the slowdown) and very ample in 2019.
Every monetary statistic contradicts the expert assessment that monetary policy is reducing the cost of money. It is simple math really — if inflation goes up by 10 per cent, and my cost of borrowing goes up by 5 per cent, the cost of money has come down. And just the opposite when inflation declines more than the repo rate. Why is this simple math seemingly not understood by experts?
There are additional factors constraining growth in 2019 and beyond. Tariff wars have intensified, world growth has slowed down, and our competitors are lowering real rates and lowering tax rates. We are raising both. The expert media fully recognises (most of them do) that higher tax rates in a slowing economy will slow GDP growth even more. But why this arrogant dismissal of the one factor the rest of 180 countries find the most potent cyclical, and structural factor, to enhance growth? More than a decade ago, RBI Deputy Governor Rakesh Mohan said that lazy banking was an important and unique aspect of Indian banking. But why do experts endorse lazy banking as a solution to our growth problems?
Bhalla is contributing editor, The Indian Express