A Seshan

Status quo would have been better

Ä. Seshan | Updated on November 23, 2017 Published on January 28, 2014

The Centre Money is at the core of monetary policy - PV SIVAKUMAR

The monetary authority should consider instruments other than interest rates to control money supply, disinflation,

There were fond hopes of a more liberal interest rate regime, but that was before the RBI announced its policy rates on January 28. The sense of hope was inspired by the apparent decline in the inflation trends and in GDP growth and the fact that the general elections will be held soon. The RBI has sent a message that it was concerned about economic and not political issues, thereby carrying out its dharma of fighting inflation.

The RBI Governor has been emphasising the unacceptable levels of inflation in his recent comments. Inflation may be down, but it is still high. The clear shift from wholesale to retail prices in the measurement of inflation comes through loud and clear in the RBI announcement.

A false trade-off

The Governor has said: “It is only by bringing down inflation to a low and stable level that monetary policy can contribute to reviving consumption and investment in a sustainable way. The so-called trade-off between inflation and growth is a false trade-off in the long run.” This is a good repudiation of the fashion among some economists — there is a certain lakshman rekha of price rise India should cross to grow at 5 per cent or so.

It is known that inflationary forces reduce the purchasing power of the rupee, reducing the quantity of goods and services bought by the common man. But that it leads to a recession due to a fall in aggregate demand is, perhaps, being recognised in official circles now. The RBI’s decision to use the interest rate weapon by raising policy rates by 25 bps has to be seen in that context.

But the question is how far it is going to contribute to disinflation. The basic problem facing the country is the amount of money sloshing around in the economy; that is further aggravated by the debt buybacks through the open market operations of the RBI. In switching over to interest rate, giving up the mantra of money supply (a monetarist legacy), authorities should not throw the baby with the bath water.

One does not argue for the return of the ‘Friedmanian’ (or Friedmanic) brand of monetarism. But there is an eternal truth in the statement that ‘money matters’. You cannot have monetary policy without money being at its centre. It’s like having a baraat without the bridegroom!

If monetarism fell into disrepute, it was because the rules of the game were not strictly followed, and it was carried to extremes. It led to the jibe that “Margaret Thatcher has done to monetarism what the Boston strangler did to the travelling salesman!”

The main problem with the RBI documents and pronouncements is there are frequent references to liquidity, but one does not know what it is. The RBI bulletin has a table on different measures of liquidity aggregates. Which one of them gets the greater attention of the Bank in deciding if there is liquidity shortage or not? Going by the operations at the window of Liquidity Adjustment Facility alone may be misleading, as we have seen days of reverse repos followed by those of repos.

Credit factor

Monetary policy deals with both the cost and availability of credit. The increase in the repo rate may or may not be transmitted to borrowing entities. Further, sectors such as agriculture and exports are protected by interest rate subventions.

Eventually, the impact of the interest rate policy is on manufacturing and service sectors. Interest forms a small proportion of the cost of production of manufactured goods. Thus, the intended aim of lowering the demand for credit may not be realised.

On the other hand, a rise in CRR will affect the availability and the cost of credit so far as manufacturing and service sectors are concerned. But to use one or the other instrument, one needs to be very clear on what one wants to achieve.

According to the macro document, a slowdown in credit off-take across agriculture and allied activities and industry was observed during December 2013. At the same time, the services sector continued to exhibit a strong build-up. The Bank assures the public that credit growth has moderated in line with the indicative trajectory of 15 per cent. Perhaps, it could have let the status quo continue and wait for some more time to make changes in policies.

The next announcement on April 1 will deal with the policy stance for 2014-15. By that time, the Bank would have taken a view on the recommendations of the Urjit Patel Committee.

(The author is a Mumbai-based economic consultant)

Published on January 28, 2014
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