The Hindu Business Line : Monetary Policy: Divorced from reality

The Monetary Policy has not attended to issues in the external sector that were crying for attention. Also, some assumptions made in the policy seem as if they have not taken reality into account.

TRYING to formulate a Monetary Policy when the RBI does not have the Budget 2004-05 and other related policies spelt out due to the goings-on in Delhi may appear as pointless as trying to score goals when there is no defined goal posts.

Yet, there were issues in the external sector crying for attention but which has gone unattended and some assumptions on which the policy is built seem divorced from reality.

First, the assumption regarding growth and inflation. Growth is projected next year at 6.5-7 per cent on top of the 8.1 per cent in 2003-04. Last year's growth has been aided largely by a 9.1 per cent growth in agriculture and industrial growth — the best in eight years. Agriculture has grown in India in fits and starts in the last 54 years.

Whenever there is a growth of 9 per cent or thereabouts, it has been mostly followed by a year of negative growth. The prime exception is 1980-81 which has to be seen in the context of what happened in the preceding two years. Even with a forecast of a good monsoon, one doubts if there will be any growth. India will be lucky if there is no drop.

As statistics show, out of the 12 years that India had a 7 plus per cent GDP growth rates since 1950-51, in 10 years the growth rate in agriculture has exceeded the GDP growth rate.

Thus, to achieve 7 per cent GDP growth rate, the country seems to need a better than 7 per cent growth rate in agriculture. Only in one year — 2004-05 — India managed a 7 per cent growth rate with negative growth in agriculture.

Even if industry does not show any growth fatigue in 2004-05 and services survive the US protectionist backlash and the dollar drop, with a negligible agriculture growth India will be lucky to see a 5-5.5 per cent GDP growth rate next year.

Second, last year the inflation was on a tight leash from the falling dollar and reduced tariffs which made imports cheaper by 7-8 per cent on average vis-à-vis domestic prices. The currency has bounced back in the last two months and the oil price rise — which is looming large — may have its impact. Added to this is the overhang of liquidity. Last year's stability in prices may be difficult to repeat.

A money supply expansion target is premised on high growth and low inflation; but what looks likely in 2004-05 is high inflation and lower growth.

Need for CBMs in volatile forex markets

Both the forex and the stock markets have seen gyrations in the least two months not seen before. In both cases the storm has blown over but has left a trail of destruction. The stock market may have recovered in two-three days but still has landed many investors with losses. The forex volatility of the last week of March, led to corporates, notably the software giants, selling a large chunk of their next year billings at rates which look ridiculous now. The forces that caused the currency volatility have not exactly gone away.

It is a let down to find that the policy says nothing of the events or how it will prevent such short term volatilities of the extreme variety so that players in the real sectors are not cornered into taking measures that compromise their ability to sustain earnings. Something was definitely expected and would have been helpful.

Even if the RBI had installed "circuit breakers" that would operate if movements exceed a specified limit, they would have acted as CBM much like the "flag march" through a riot-hit area.

The measures mentioned in para 49 of the policy have potency in the medium- or long-term only.

The RBI could have armed itself with the right to operate measures such as automatic impounding of a specified per cent of inward receipts, imposition of tax, release of currency to the exporters or recipient customers only after a certain number of days after receipt, mandatory forward cover for payments, and so on.

These and an indication on when (at what level of volatilities) each of these will start operating would have been very reassuring helped to prevent largescale volatilities.

The RBI has done something similar in the money markets (para 72). It could have repeated the same in the forex market.

(The author works for a large chemical manufacturer-exporter. The views are personal.)

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