Rate cut advocates are wrong

We are familiar with stories about serial killers in novels and films. We have had serial killer statistics about the Indian economy for quite a long period! Thus, industrial production in November 2012 recorded an annual decline of 0.1 per cent compared with an increase of 6.0 per cent a year back. The corresponding growth rates for April-November were (-) 1.0 per cent and 3.8 per cent, respectively.

Exports in December were down by 1.9 per cent year-on-year, marking a straight declining trend for the eighth month. For the first three quarters of the fiscal year, exports were down 5.5 per cent from a year back.

The weakness of the export sector, accounting for one-fifth of the Indian economy, has raised the current account deficit, which hit an all-time high of 5.4 per cent of gross domestic product in the July-September quarter and has brought pressure on the rupee.

There is no respite on the price front. The Wholesale Price Index (WPI) recorded an annual inflation rate of 7.18 per cent in December 2012, compared with 7.24 per cent and 7.74 per cent a month and a year back, respectively. It has led to euphoria in some quarters, which are demanding a reduction in the policy rates since the ghost of inflation has been laid low!

Some analysts calculate the inflation in the financial year so far as 4.72 per cent, in contrast to 5.22 per cent in the corresponding period one year back. The core inflation is below 5 per cent and the RBI should not hesitate to reduce the rates, so the argument goes.

Such irrelevant statistics are cited because of the impression given by the central bank that it is the WPI that is a true measure of inflation, although it does say that it looks at a variety of indicators while deciding on policy measures.

For the common man, it is the Consumer Price Index (CPI) that shows the impact on his daily life. And the CPI recorded an inflation rate of 10.56 per cent in December 2012, rising from 9.90 per cent a month back.

We have abundant food stocks but still there is a rising trend in the prices of cereals. It is a case of mismanagement of buffer stocks about which monetary policy cannot do anything. As I argued earlier, it is time for the RBI to categorically state that, although it looks at several factors in formulating policy, its focus is on the CPI. It should also redefine “core inflation” in a contrarian way to mean inflation in food and fuel prices only.

If it is able to make these two changes in its analytical approach, it will save itself much of the pressure brought upon it to liberalise policies on the basis of the trends in WPI and the Western definition of core inflation, that is totally irrelevant in the Indian context.

Autonomy of RBI

There is a tendency on the part of some observers to consider the current RBI head as a lame duck Governor just because his term expires in September and there is no likelihood of his getting another extension of his tenure due to the spirit of independence he has displayed in policy making.

In my opinion, the above-mentioned factors should work in his favour to continue to formulate policies on the basis of what is best for the economy, while reckoning with their well-known limitations. He is bound by the mandate in the Preamble to the RBI Act, viz., ensuring “monetary stability” or preserving the purchasing power of the rupee. And he gets his autonomy from that mandate, and not from the Finance Ministry. The central bank can become autonomous by exercising it in practice, supported by the Preamble to the RBI Act, and not by any special legislative supplication.

Will policy change help?

How will a reduction in policy rates help in reviving the industrial sector or exports? The problem is a decline in demand, both domestically and from the external sector. Inflation has led to a decline in the quantity of goods and services purchased. The external demand is affected by the poor economic conditions there.

Yet another reason given by votaries for a relaxation in policy is the liquidity shortage in the market, as measured by the repo transactions at the RBI window. The liquidity shortage is at the level of a few individual banks, exploited by others with surplus SLR securities by utilising the repo facility for arbitrage profits. It also serves as a refinance window for regular business in a covert manner.

How does one explain the subdued call money rates or the high bid-cover ratios in the auctions of government securities and the falling trend in their yields?

The CD ratio of 77.61 per cent or the incremental CD ratio of 73.11 per cent for the financial year, as on December 28.2012, cannot prevail, if there is a shortage of liquidity. The RBI has done enough to improve liquidity through its buy-back operations. Year-on-year it has monetised fiscal deficit retroactively to the extent of Rs 1 trillion. At most the central bank can reduce the Held-to-Maturity category of SLR securities to 23 per cent of net deposit liabilities, which should provide relief to banks in liquidity shortage. The saver is getting a raw deal due to the prevailing nil or negative real rates of interest. He should not be hit further by any reduction in the interest rates.

(The author is a Mumbai-based economic consultant >blfeedback@thehindu.co.in )

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