Critics of the tight money policies of 1994-96 fail to recognise that the GDP slowdown occurred two years later. Similarly, the RBI is not responsible for the slowdown of 2011-12.

The Reserve Bank of India’s (RBI), Mid-Quarter Monetary Policy Review communiqué of June 18, 2012, cogently sets out the reasons for not easing monetary policy. The growth-inflation dynamics point to several factors being responsible for the economic slowdown, and easing monetary policy would merely exacerbate inflationary pressures.

The Finance Minister, on June 16, 2012, said that “he was confident that the RBI would adjust the monetary policy”.

On June 17, 2012, Finance Ministry officials counselled public sector banks to bring down interest rates, if RBI cuts policy interest rates. India Inc. had been storming the citadels of monetary towers clamouring for easing of monetary policy to stimulate investments.

The RBI was faced with slowing growth, inflation, on a-year-on-year basis at 7.6 per cent on the Wholesale Price Index (WPI) and 10.4 per cent on the Consumer Price Index (CPI) —outside the RBI’s comfort zone — a weak global environment, a fisc out of control and a depreciating rupee.

The wedge between deposit growth and credit expansion also ruled out any easing of monetary policy. The predictable response was that India Inc. was “angry”.

GOVERNOR HITS BACK

In an unusually hard-hitting speech, at the Indian Merchants’ Chamber on June 19, 2012, Governor Dr D. Subbarao stressed that there was nothing inevitable about the India growth story and that achieving growth was a shared responsibility of the government, the RBI and economy managers. He emphasised that the blame game cannot go on; it was not good for anyone, particularly the majority of the population. The poor are vulnerable to inflation as it is a regressive tax which hurts the poor the most; their voice, silent as it is, must be heard.

Governor Subbarao comes out fighting from his corner, and this speech will go down in the annals of RBI history as one of the most powerful and frank speeches by an RBI Governor.

The matter will not end here, and the RBI should be ready for a battle of attrition. The RBI can take solace in the fact that it is doing the right thing, if it comes in for bitter attack; and conversely, doing the wrong thing, if praise is heaped on it.

Economists, analysts and India Inc. will continue to attack the RBI for its 2012 monetary policy for the next twenty years!

BLAST FROM THE PAST

A case in point is the monetary policy period of 1994-96 which, even today, is subject to strong criticism. It is fortunate that the RBI Annual Reports for June 1995 and June 1996 provide copious information on what happened and what the RBI did.

From the latter part of 1993-94, there were heavy capital inflows. The RBI, in its endeavour to prevent inflation and an appreciating rupee, intervened in the forex market to buy up foreign currency and to avoid the adverse impact of monetary expansion it undertook large open market sales of dated securities.

As the RBI’s stock of government securities dwindled, from June 1994 onwards, there was a phased increase in the CRR on overall liabilities and such non-resident liabilities as were exempt for the CRR were brought under the CRR.

In February-April 1995, the maximum deposit rate was raised in stages from 10 per cent to 12 per cent and export refinance facilities were curtailed.

With double digit inflation, reduction in inflation became a priority for policy action. The point-to-point WPI inflation, which was 10.4 per cent in 1994-95, was brought down in 1995-96 to 5.0 per cent.

At that time, there was no composite CPI index, but industrial workers’ CPI came down marginally from 9.7 per cent in 1994-95 to 8.9 per cent in 1995-96.

The persistent criticism of the 1994-96 monetary policy, even today, is that monetary policy was too tight in 1995-96. This is a total canard. While in 1995-96 there were sales of forex by the RBI, there was a substantially larger release of the CRR. This is conclusively brought out in the RBI Annual Report for 1995-96 (Page 3).

There was a very short period when liquidity was tightened around November 1995, as banks were borrowing heavily in the call money market and using the money to buy forex in the market.

To prevent this from happening, the RBI temporarily shut off support to the money market. The call money rate zoomed to stratospheric levels but once the pressure on the forex market eased the RBI quickly restored support to the call money market.

Critics of the RBI policies of 1994-96 fail to recognise that the GDP slowdown occurred two years later; the economy was growing beyond its potential and a slowdown was inevitable.

An impartial analysis by Rajiv Malik many years ago conclusively showed that the RBI policies of 1994-96 had nothing to do with the slowdown of growth in the subsequent two years.

Dastardly attacks on the monetary policy of 1994-96, which even continue to date, are a reflection of economists resorting to political nonsense to gain a few brownie points.

The RBI Annual Report for 2011-12 should convincingly debunk the myth that the slowdown of 2011-12 was due to an excessively tight monetary policy.

The RBI should use its best judgement to continue to formulate its monetary policy and not take heed of unconstructive criticism. The RBI must recall the old adage; “Dogs may bark but the caravan moves on”.

(The author is an economist. blfeedback@thehindu.co.in)

(This article was published on June 28, 2012)
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