MAVERICK VIEW. Let’s accept the limits to growth

The Reserve Bank of India (RBI) will announce its First Monetary Policy Review for 2015-16 on April 7 against the backdrop of the agreement between the Centre and the RBI on Monetary Policy Framework signed on February 20, 2015. The detailed operating system is yet to be announced as also the determination of the composition of the Monetary Policy Committee.

The RBI is meant to have a greater degree of autonomy in deciding the monetary policy and, therefore, would be more accountable. The RBI would need to deftly steer a policy path which would take into account domestic developments on output, prices and the fisc, the government’s articulation of its preferred monetary policy path,` international economic developments, the exchange rate and India’s competitiveness.

There is an erroneous view that monetary policy should have a narrow focus on inflation and with the year-on-year inflation rate falling in the recent period, the appropriate policy response should be to reduce policy interest rates and ease liquidity. A rapid easing of the monetary policy would have adverse implications for a wider gamut of macroeconomic policies. Forecasts by various international agencies put India’s real growth in 2015-16 at 7.5-8 per cent and the Economic Survey puts growth at 8.1-8.5 per cent. Given these forecasts, international pronouncements are that India would contribute to global economic growth more than the US, albeit less than China.

These international pronouncements would warm the hearts of influential Indian policymakers, opinion makers and analysts to advocate a strong thrust towards the magical double digit growth rate and these advocates would root for lower interest rates, easier liquidity, a strong rupee and a strong fiscal stimulus to step up overall growth. Finance Minister Arun Jaitley recently said, “I am quite certain we will see more cuts (in policy rates) in future. But as of today if you ask me how much and when, it is the domain of the RBI and I would leave it to them.”

While this stance is an improvement over the previous government’s pronouncement of open hostility such as “we will walk alone”, an ideal situation would be for the finance minister and top government honchos to refrain from revealing the preferred monetary policy action, particularly close to the monetary policy announcement.

We in India need to be cautious when international opinion cheers from the sidelines. In between the lines would be the expectation of the international community that India would be the locomotive for global growth by rapidly opening its doors to foreign business and that it would maintain a strong rupee.

Contrast the euphoria in India to the caution in China. Vice-Premier Zhang Gaoli, on March 22, 2015, said “it is both impossible and unnecessary to maintain the very high growth of the past. We have paid the price for that. It is not sustainable”. The Chinese authorities are unequivocal in their acceptance of the doctrine of potential for growth and the need to recognise that there is a limit for growth.

In India, advocacy of the concept of a limit to growth is treated as heresy. We need to recognise that gross domestic savings in recent years have fallen from 36 per cent of GDP to 30 per cent, and unless effective measures are taken to stimulate savings, growth will be stunted.

With strong signals that US interest rates could rise sometime in 2015, most currencies have been depreciating vis-à-vis the US dollar. Differential interest rates would warrant that the rupee depreciates significantly and as such it is unequivocally clear that the current exchange rate is grossly over-valued. An overvalued rupee brings in its wake, lower exports, higher imports, rendering large tracts of Indian industry, particularly micro, small and medium, uncompetitive. Our macho spirits calling for a strong rupee result in irretrievable damage to the Indian economy.

Given the present inflation rate, the expected growth of the economy, the possible increase in US interest rates and the likely continuation of large foreign inflows into India, it would be prudent to keep unchanged the policy repo rate of 7.5 per cent as also the accommodation provided by the RBI. If the US policy interest rates start rising in June 2015, or somewhat later, a reduction in Indian policy repo rates now would warrant sharper increases in Indian policy interest rates which could be dislocative.

With the continued inflow of foreign funds, it is likely that there would be an increase in domestic liquidity which would warrant open market operations sales of government securities by the RBI. A premature reduction in policy interest rates would result in strong pressure to reduce lending rates of banks which, in turn, would require a reduction in banks’ deposit rates which would result in a significant reduction in banks term deposits which would dislocate the asset-liability maturity mismatches.

While the RBI would, in all probability, indicate a host of regulatory/operational measures, it would be unfortunate if the RBI continues to use a Nelson’s eye on the blatant cartelisation of the savings bank deposit rate at 4 per cent.

While cartelisation issues are within the purview of the Competition Commission of India (CCI), the RBI cannot absolve itself. The cartelisation by banks is unconscionable and, as Sameer Kochhar of Skoch puts it, tantamount to stealing from the poor to reward the rich. The RBI cannot be a mute spectator while there is a gross financial atrocity. In the absence of a proactive role by the RBI, monetary historians would ask: “Why did the RBI sleep”?

The writer is a Mumbai-based economist

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