Opinion RBI — the Lone Ranger syndrome

We can debate the causes of each of these disturbing facts ad infinitum,as we are more than capable of doing and able to do. But nothing will change the ugly reality. Macro-economic policy has been a complete failure in India. This was,and is,expected. With the dysfunctional politics of the US,and the dysfunctional economics of Europe,it is a wonder that we are growing at all.

But wait. We can’t blame the Europeans any more,at least since October 2011. I belong to the camp that the European Central Bank,under the leadership of Mario Draghi,has distinctly changed course,and changed course for the better. And in a week,the dysfunctional politics of the US may appear to have peaked. Whoever wins the presidential election,it is unlikely that the future of politics and cooperation between the two major political parties in the US will be worse than what we have witnessed in the last several years.

So very soon India will be all alone,and in a format its Lone Ranger leaders just love to be. What makes them take on the Lone Ranger mantle? Is it because of a primary belief,and revelry,in the delusion that après moi,le déluge? That is,but for them,the whole system will collapse. But hey,hasn’t it collapsed already? Maybe it is because of a belief that radical surgery is needed to stem the rot. Possibly,but only the Lone Rangers have the knowledge and wisdom of the effectiveness of the surgery?

The accusation that there was policy paralysis in India was an accurate one until September 12. True,the change has been observed for only a month-and-a-half,but the change is remarkable,and of a non-Lone Ranger kind. Indeed,the policies being followed now by the Manmohan Singh government were what its own leading economists,and tonnes of others,have been recommending for at least the entire eight years the UPA has been in existence.

And these policy changes are not in an isolated vacuum — they are well within the political and electoral reality of India. This is a change that should be welcomed and encouraged. The other positive and important macro reality in India is that the change in the level of inflation,again no matter how measured,is structurally down from its more than double-digit levels to something close to 5-7 per cent. Core inflation,we are told,is now “sticky” at around 5.5 per cent. Given that our long-term target is for inflation to be around 4-5 per cent,I would have thought that this stickiness was virtuous.

So with policy paralysis down,government beginning to be responsible,and inflation declining,the RBI decided to keep the repo rate at a high 8 per cent. It decided to wait until it could see the whites of the eyes of low inflation before doing anything. The arguments in favour of the RBI continuing its out-of-the-box stance on monetary policy were as follows. First,that real rates of interest are already too low in India. One metric of judging real short-term rates is that with normal GDP growth,the level of such rates is around 1 per cent in developed economies and 2.5 per cent in emerging markets. But no country is growing normally in 2012. When growth is considerably below normal,so are short-term rates,and negative real rates is the reality in most countries,developed and developing. But not in a Lone Ranger country like India,where such rates are positive. And long-term rates are abnormally high as well — at 16 per cent nominal,or 8 per cent real.

Now from the near plausible to the ridiculous explanation for the RBI staying pat at 8 per cent. I must confess that I hadn’t heard this line of reasoning for at least the last few decades. I apologise for my deficiency. But the ancient regime,and equally Lone Rangerish,argument for high if not higher repo rates is that such rates affect real deposit rates,which affect the rates of household saving. Now there are precious few,if any,empirical studies worldwide showing any relationship between savings rates and real deposit rates. But there are several studies which indicate that savings rates are positively associated with the rate of growth of income. And since the RBI is fond of quoting that real interest rates were higher during the high growth period of 2003 to 2007 (factually wrong but never mind),it should also note that this was the period savings rates galloped from 23 per cent of GDP to some 13 percentage points higher!

But the argument is not about evidence,as the Manmohan Singh government and the finance minister,P. Chidambaram,have just found out. The argument is about central bank independence,and Lone Ranger thinking.

Unfortunately,the perceived reality is that central bank independence can only be asserted by disagreeing,vehemently if possible,with the Centre,regardless of facts or policies. So my unsolicited advice to the FM — please announce that you expect a responsible and independent and forward-looking and inflation-fighting RBI to raise the repo rates at its next meeting. The RBI can then cut rates and help Indian GDP growth to recover. And we can all praise RBI independence,and of the Lone Ranger finally shedding its quixotic behaviour.

On second thought,maybe the FM should not actually say that. With inflation declining only slowly,and the growth rate not falling fast enough below 5 per cent,the RBI may actually follow the FM’s advice. But what about central bank independence then?

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