BJP should cultivate RBI

Once the investment cycle gets re-established, jobs will be created and you will see the supply side being addressed, which is the correct way to tackle inflation. You cannot address inflation by hoping to choke demand by increasing interest rates and in the process kill the economy and growth.

Modi-ji articulated some thoughts in our National Council meeting about the price stabilisation fund. If you go into his 2011 recommendations when a committee was setup under Modi ji on steps to tackle inflation, he came up with some brilliant ideas and not one of them spoke about increasing interest rates.

I think governor Rajan is only aggravating the problems and making it worse by increasing interest rates. In the last six years they have increased interest rates multiple times but inflation has not come down at all, it is relentlessly increasing. Food inflation certainly has no correlation with interest rates. I have not been able to understand why they are tackling food inflation by increasing interest rates.

Let Indian manufactures flourish in a low interest regime. If you make interest rates so prohibitive, how will our manufacturers compete with the onslaught of foreign goods. This is the reason we have a $ 31 billion trade imbalance with China and that is going to get worse with interest rates being what they are, regulatory environment being vitiated and corruption at such high levels.

These are some of the comments made by Mr. Piyush Goyal, Treasurer of the Bharatiya Janata Party (BJP) in an interview to Economic Times. The full interview is here.

He had made some good observations to make on letting banks raise capital from the public, on sale of shares to the public by government companies, etc. We should welcome his opposition to the re-capitalisation of Scooters India Limited by the Government and the government running airlines and hotels, etc.  However, it is a pity that he ducked the question on privatisation.

The lingering doubt remains if the NDA – in its current form – is as committed to centre-right policies on economics as the government under PM Vajpayee turned out to be from the period 2002-04. There is a lot that the government can and should do and should do better. One is to stop being a petulant litigant. The Vodafone case comes to mind. But, the government cannot govern the country and run businesses too. It has to let go.

More than these, his comments on managing inflation are worthy of reconsideration (on his part, that is). Inflation can be handled if supply constraints are removed. It is hard to deny that. Whenever the Indian economy has grown at more than 8% for more than two years, prices had moved higher. Indian economy’s speed limits have to be raised through better infrastructure and production. No doubt.

But, until that happens, what should the Reserve Bank of India do? Wait for supply improvement to happen, without trying to cool down inflation expectation? If it does not put upward pressure on the government’s borrowing cost (in fact, the RBI rate pressure on the government is not strong enough), how will the government feel the pain of its profligate ways?

Ok, interest rate increases have not reduced the inflation rate, on the face of it. Non-food manufacturing inflation (in the wholesale price index) rate has come down to below 3%. This is due, in part, to declining credit growth. That, in turn, is due to higher interest rates, at least partially. With food inflation being where it is, if non-food inflation too has remained high, where would the inflation rate be now?

In other words, it is one thing to argue that the rate of inflation has not come down fast and enough. But, it is important to ask the counterfactual question: where would inflation rates be, without even these modest interest rate increases? Would India have escaped the turmoil in emerging market stocks and currencies in January had the RBI, under Raghuram Rajan, not raised rates in the last few months? Where would inflation be with a continuously depreciating rupee?

Two things have to be etched in the foreheads of people discussing economic policy: ‘counterfactual’ and ‘productivity’. We will come to the second one later.

Let us turn our attention back to inflation and interest rate hikes by RBI. Let us run a thought experiment. W all know that the Indian corporate sector borrowed close to USD50 billion dollars or more in 4+ years starting in 2009 in overseas markets. We know that the Government of India does not borrow in foreign currency. Small, medium and unincorporated enterprises do not or cannot. So, obviously, it has to be only the large incorporated sector. USD50 billion is not a small sum. At an average exchange rate of around INR55=1USD, that amounts to INR275,000 crores or INR2.75trillion! That is a lot of money.

With corporations having thus overcome the interest rate disadvantage, allegedly imposed by the RBI on them, what did they do with it? If they had invested it wisely and productively, would India have suffered from high current account deficit in the last few years? Domestic production would have been higher. The private sector could have blunted the ill-effects of the fiscal policy of the Government of India. Either it did not invest wisely or borrowed through their Indian operations to invest elsewhere – outside India. Clearly, there are reasons other than interest rates. The Chief Minister of Goa Manohar Parrikar knows them too well.

This train of thought automatically and correctly leads one to exclude RBI and its rate hikes from the list of factors that held India’s economic growth and supply side response back.

I was going through the papers written by Dani Rodrik and his co-authors in 2008 on the economic restructuring of South Africa. The links were made available by one of the commentators on his latest piece, ‘Death by Finance’ (a must-read, btw).

One of the ways a country can boost its domestic production is to ensure that investment took place in tradable goods sector. The second most important thing for supply to be augmented is to use the existing capacity and resources productively. According to Professor Robert Solow, productivity is the only thing that matters for economies. The interview did not mention ‘productivity’ even once.

The restructuring proposals made for South Africa are must reads for BJP think-tanks and advisors and ‘would be’ policymakers in the party. South Africa’s problems with boosting its manufacturing and the suggested solutions are highly relevant for India too.

In the meantime, it would make sense for aspiring BJP policymakers not to burn their bridges with the current management in RBI. They are doing a good job. They have shown themselves to be pragmatic, flexible and open-minded. It is undeniable (though hard to prove conventionally) that the presence of Raghuram Rajan has lent credibility and a floor to the Indian rupee. It is not easy for Western policy and academic types to trifle with him.

When he sends out a ‘threat’ to the West on adjustments in emerging markets and how they won’t like them, the threat hits its target. It is widely noticed.

If the BJP comes to power under Modi’s leadership – as it appears likely and as this blogger wishes – they would have to work closely with the Reserve Bank of India in many ways, from fiscal management to non-interference in commercial decisions of banks to designing and implementing capital management measures, in the face of continued and more unconventional policies from the West. Such policies are not only likely to get bolder but also remain as indifferent to emerging market concerns as they are now.

Emerging economies have to pull together – both within and without – if they are to mount a credible challenge to the discredited Western policy orthodoxy which is hurting them considerably now. Emerging economies like India should not only get their internal economic house in order but they should also articulate their case internationally for global monetary regime change with substance, knowledge and sophistication.

The BJP, in due course, might come to acquire all these but right now, RBI has it. It makes sense to cultivate RBI and build bridges with it rather than striking a solo note.

One thought on “BJP should cultivate RBI

  1. I feel there is an imminent risk of BJP perceiving Rajan as UPA’s boy and sidelining him, which according to me would be a big mistake.

    Rajan, I think, has the right ideas and direction for the RBI and indeed the country’s financial system. He badly needs support of constructive fiscal policies, which have been the bane of India’s economic mess.

    Hope the next Govt is wise enough to realize what an asset it is for India to have him at the helm at such a difficult period.


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