RBI opens new window

The annual monetary policy statement of the Reserve Bank of India (RBI) for 2013-14 announced last week drew predictable responses from industry and finance sector representatives.

After witnessing an inexorable decline in GDP — the bellwether sign for all that is important to the health of the national economy — many leading lights seemed to have found in the RBI’s third modest cut in its repo rate by 25 basis points an augury for a better future.

This is the third time in a row that the RBI has reduced one of its key policy rates; all told so far, the central bank’s overnight lending rate has fallen by 75 basis points since September. Should that not indicate something positive?

Many read in that a ‘softening’ of its position: The old uncle at Mint Road is finally relenting to the cries from business houses and the corridors of North Block and the Prime Minster’s expert planners for growth and begun to release cheaper money.

Inflation is a problem yes — you can almost hear a sigh of exasperation — but don’t spoil the party for heaven’s sake!

Interest alone matters?

Markets are more hard-nosed. They factor in the modest generosities of the central bank. But hope springs in the minds of stakeholders — reared on a steady diet of high-calorie GDP growth, rising skyscrapers and profits, cheap money and debt — basically on the simple, sometimes cretinous, belief that the only deterrent to more of the things fewer Indians can afford or really need is cheap liquidity.

In large part, policymakers in New Delhi have downplayed their own inaction, valorised low interest rates as the driving force of growth and, in the bargain, demonised the central bank as the party-pooper.

At no other time before the last couple of years have so many policymakers sent so many hints to Mint Road to do the right thing and help a dispirited economy.

But it takes just a click of the mouse to learn how low or near-zero interest rates may not really help pull up an economy suffering from more than just a lack of funds.

History is replete with examples of aggressive doses of liquidity failing to crank up the economic cycle; look at the pre-Keynes Depression era-policy world.

Passing the buck

The RBI understands this as most policymakers would. But New Delhi must give the impression of acting and the only way it can do that is to get others to act — and pass the buck. For its part, the RBI sticks to its knitting and behaves accordingly.

The statement it issued last week reminds us of the mandate it has: To consider, above all, inflation and, by implication, its deleterious impact on the entire economy.

That is why it ignores the downtrend in the increase in the wholesale price index as the conventional (though erroneous) guide to its policy stance: A dip in headline inflation should normally turn it more pro-growth and, therefore, more generous. But its focus is on inflationary expectations and on uptick in food inflation.

And, there, the scene is not pleasant. “Largely driven by food inflation, retail inflation, as measured by the new combined (rural and urban) consumer price index (CPI) (Base: 2010=100), averaged 10.2 per cent during 2012-13. Even after excluding food and fuel groups, CPI inflation remained sticky, averaging 8.7 per cent. Other CPIs also posted double digit inflation.”

What does the RBI have to say about growth — the lack of which has been so often ascribed to its failure to ring in cheaper money for the middle class to splurge on their second home or third car? Very correctly here, it passes the buck back to New Delhi.

And as for growth…

“Sustained revival of growth is not possible without a revival of investment” it says. And that is not happening because of “…governance concerns, delays in approvals and tighter credit conditions.”

The key problem lies in “governance concerns”. By pointing to this, the RBI elevates the problematic, as it were, from the terrain of pure economic/monetary principles — interest rates as a driving force of economic expansion — to the political. Simply put, not all the liquidity in the world will convince a bank to lend, if it feels projects may get delayed and its money may get stuck on account of lack of governance.

Extra-economic considerations plague revival in the West as well, despite repeated quantitative easing by the central banks in the US, England and, now, Japan, with China threatening to follow suit. Credit growth there is slack, but the liquidity unleashed finds its way to emerging and developing economies (EDE), causing headaches to central banks such as the RBI.

That is why the annual statement cautions: “Even as the large CAD (current account deficit) is a risk by itself, its financing exposes the economy to the risk of sudden stop and reversal of capital flows. Although the CAD could be financed last year because of easy liquidity conditions in the global system, the global liquidity situation could quickly alter for EDEs, including India…”

What the RBI does not tell us is that quantitative easing policies cause currency devaluation, and with more countries following suit to cheapen their exchange rates, medium-size exporters such as India could get affected, upsetting even the most honourable domestic policies.

At the end of the day, the RBI statement’s modest growth projection of 5.7 per cent does not mean much or, for that matter, even the 6 per cent other policymakers dream of.

The crux of the matter is not the number per se but the way a country is run; governments do matter and governance does shape India’s economic fortunes — or misery.

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