RBI strikes the right note

I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said.

Alan Greenspan , at a Congressional committee meeting

If there is one outstanding feature in the announcements of the Reserve Bank of India (RBI) in the recent years it is their clarity and transparency, even though one may not agree with the findings and policy prescriptions. They do not carry any Greenspanian ambiguity.

Its latest Annual Policy Statement, supported by the accompanying document on developments in the economy, has articulated well the need for taking some drastic steps to deal with the current economic situation. What I like is the clear-cut statement that growth may need to be sacrificed in the interests of price stability.

FOCUS ON PRICES

The RBI has indeed delivered a googly if one goes by the immediate reaction of the markets, bankers and industrialists. The adverse reaction of the markets is to be expected. But they will be back to boom conditions before long as we have seen more than once in the past.

The 50-basis point hike in repo and reverse repo rates and the increase in the interest rate of savings bank accounts and provisioning requirements for non-performing loans are moves in the right direction. The recommendations of the Working Group on the operating procedure for monetary policy were expected to be approved by the Bank. Habits die hard -- the Bank has given the usual forecasts of inflation and growth in money supply, credit and deposits. If one considers its projection of GDP growth it would appear that the Bank has provided for accommodating 4-5 per cent inflation in the expansion of money supply. This is small mercy since the end-of the-year estimate is 6 per cent. The stance of monetary policy of the Reserve Bank includes, inter alia, the following: “Foster an environment of price stability that is conducive to sustaining growth in the medium-term coupled with financial stability.”

There is no mention of the medium-term low inflation rate aimed at that used to find a place in the previous reports. Obviously, the Bank has realised the futility of such a forecast when it expects the short-term inflation to be 6 per cent or more. Does it mean a sense of helplessness on the part of the central bank?

SUPPLY SHOCKS

In the document on macro developments, the RBI has recognised the importance of bringing down the level of prices instead of referring only to inflation rates.

An indication of the average monthly price rise during the year, compared with those in the previous years, would have presented the picture in proper perspective, since common man suffers throughout the year and not at the end of the period only.

That monetary transmission is usually more effective in a deficit liquidity situation than in a surplus one, as stated in the document, is old hat. It is a standard textbook maxim in monetary economics that you can pull a string but not push it! In the chart on page 25 of the document, if actual numbers of the money multiplier had been given it would have been helpful to the researcher. He has now to read them off the graph, which may not be accurate. There is a reference to supply shocks. Pulses, vegetables, fruits, fish and milk contributed much to inflation in 2010-11.

The RBI could have substantiated its reasoning by giving data on their output compared with those of the previous year. The other food crops and manufactured goods did not produce any supply shock.

EXTERNAL ACCOUNT

The limitation of the Real Effective Exchange Rate (REER) as a pointer to export competitiveness is also spelt out. However, the elasticities of demand for exports and imports should also have been given recognition along with the others. It may explain the buoyancy in exports despite the appreciation of the rupee in REER terms.

The document says that investment income receipts declined significantly over the corresponding period of the previous year, mainly due to the persistence of lower interest rates abroad. The growth in the outflow of investment income to foreign countries needs to be taken note of. The net negative position increased from $5.2 billion in 2009-10 to $9.9 billion next year.

As a proportion of GDP, the financing of domestic capital formation by foreign savings rose from 1.2 per cent in 2007-08 to 2.3 per cent in 2008-09 and 2.8 per cent in 2009-10. In the past, the country used to claim proudly that domestic investment was self-financed, the role of foreign saving being limited to only around 1 per cent of GDP.

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