A confused, enigmatic RBI

A riddle wrapped in a mystery inside an enigma. That was Winston Churchill’s description of the erstwhile Soviet Union way back in 1940.

That description could well apply to the Reserve Bank of India at the current juncture, particularly after its widely disregarded moves – commencing July 15 2013 – to tighten financial market liquidity.

We have deliberately ended the above sentence at “to tighten financial market liquidity” and not gone on to say what is sought to be achieved by that tightening. For, the RBI itself seems unsure of what it is to do further and what is to happen next.

It has, therefore, diplomatically passed the buck in its policy review with some high-sounding jargon – “the time available now should be used with alacrity to institute structural measures to bring the country’s current account deficit down to sustainable levels”; as if structural measures such as raising industrial productivity to enhance export competitiveness, better physical infrastructure such as roads, ports can be implemented any time soon.

Looking at the reactions post the RBI’s moves, one does think that July 15 is almost a black letter day for the central bank – for everybody seems to be so completely surprised and upset.

Only till a few weeks back was almost everyone saying that the RBI could and would cut “interest rates” at its next policy review.

Stock market investment advisors wrote that the “up” cycle in interest rates was well over. Housing loan advisors were advising prospective borrowers to take up floating rate loans as there was a series of rate cuts coming up!

In the language of such investment advisors, the RBI could well be described as having an “AAA” policy – arbitrary, asymmetric and ad hoc!

A blitzkrieg of speculation has consequently taken over in the markets with people liberally giving their views as to when and how the RBI will “roll back” the measures, why it should roll back, why the RBI’s measures will not spill over into the general structure of interest rates etc.

Why is there is so much of mystery surrounding the RBI’s moves -- and about-turns in the financial markets and the resultant upsets and unpleasant surprises in the investor community? We also seek to find out what can enduringly eradicate such mystery and “arbitrariness” surrounding the RBI’s moves.

Single point agenda

The single most important take-away from the developments of the past couple of weeks is that there is no single anchor or economic objective for the RBI. That appears to be the prime source of all the mystery.

If at all any lesson is to be learned from this latest episode, it is the criticality of giving the RBI a single point agenda and mandating it to attain that.

The RBI titled its measures as meant to “address exchange market volatility”. Since volatility can be measured, it would help greatly if the RBI were to state its objective in quantitative terms. The market can then draw its own inferences as to whether more measures are needed or not. The scope for confusion would be greatly reduced.

If that is not feasible, the central bank should then seek to explain what other economic or market objective it seeks to attain with its measures. Is it some real output number like industrial production, is it some level of the long-term government bond rate or some other financial market variable?

Since the RBI has been mentioning all these as among its concerns, the market is justifiably focused on all these variables.

We are, therefore, all over the place as regards prognostications and speculations as to when, how and why the RBI will do what it should or should not do.

It is probably a high point in obfuscation when the RBI says that it will take “whatever measures are appropriate keeping in view the growth-inflation dynamics and macro-economic stability”.

High inflation

What is macro-economic stability and what can be the central bank’s contribution?

High domestic inflation is arguably the root cause of all the problems the markets are facing at the current juncture. It is high inflation (and higher inflation expectations) which are keeping imports so large, despite decelerating output growth. The plight of the local electrical and electronics industry is evidence enough.

High generalised inflation was implicit in the RBI Governor’s complaint (in July 2012) that he pays Rs 150 for a hair-cut for which he paid Rs 50 a decade ago (a CAGR of 12 per cent). We do not import hair-cuts – but there are scores of other services whose imports have zoomed, or whose exports have fallen because of high local inflation.

It is high local inflation which makes woman farmer Leelabai of Vidarbha (highlighted by P.Sainath in The Hindu, July 17) complain of high-cost local inputs – which comprise a range of goods and services produced in the non-rural economy – and, therefore, contemplate quitting farming.

And, it is medium-term inflation (say, a year forward) which the RBI can significantly impact and influence (if not completely determine) with its policy moves.

The RBI does not have much (if any) control over the exchange rate or any other financial market variable or real economy variables such as industrial output. All such talk is so futile.

Squelching high local inflation should be the single point agenda for the RBI. That is what will clear the RBI enigma.

(The author is a Chennai-based financial consultant.)

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