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Friday, December 16, 2011

What the RBI could have done differently....and why

The following is my humble and (maybe) rather simplistic assessment of RBI's actions of late....You may differ, and maybe you are right :)

Amidst the reigning depression and panic, all eyes are on Subbarao (the RBI Governor) & Co. today as they crank out their version and view of the economy and the policy stance going forward. But is RBI’s policy so important to the man/ woman on the street? What difference a 0.25% increase or decrease in interest rates will make to the common man? A lot, if you ask me. Basics of that, will post in a subsequent post later.

However, despite our central bank being one of the best managed and best intentioned bank in the world, there are some aspects, in my view, where RBI could have acted better. First, while the move to put curbs on the Forex markets speculation via the futures contracts was much needed, it was rather late in acting. Much of the pain had already been borne by genuine producers. I think that if the RBI would have hinted at such a move earlier, it may have arrested the decline much earlier. Instead, the silence on the issue was deafening and stoked much speculation.

Also, in keeping a tight leash on the economy and by curbing growth, I think that the RBI has erred on the side of caution for far too long. Currently, the nation is in throes of slowdown and job losses and pay cuts loom ahead. When due to its own assessment, the inflation in India was a combination of higher global prices of commodities and oil, on the domestic side and constraints on supply was the main culprit, then the RBI should have not targeted on moderating demand.

Plainly speaking, when supply was inadequate, RBI should have taken measures to boost supply (if it can). Instead, by raising rates, it chose to curb down demand and induce slowdown in the economy. When demand was not the culprit, why punish it?

Hence, even though we agree that high inflation is bad for development, I don’t think it very wise to slowdown growth in India when clearly the world is in a soft interest rate regime. A slow growing India, with per capita income still being a measly 7% of US, 10% of UK, 12% of the troubled Greece and 45% of China, we are much weaker to compete if there is a mad rush for global commodities with each currency losing value. 

See it like this, if an Indian can afford to pay $100 for a barrel of say, crude oil, a Chinese can afford $221, a Greek can pay $836, an Britisher can pay $1029 and a US citizen can pay $ 1,375. You can well guess, who will win the auction, if it comes to that.

The external situation is is bad with US, China and Euro region all fighting slowdown. Most of them, except China are printing money, the governments are laden with deficit economy and all of their demographics are also wonky with too many old and dependents putting necessary but heavy burden on Govt. spending.

Such economies will and already are, printing money (deficit financing by incurring debt) and thus will stoke inflation sooner or later on scarce global commodities. When currencies lose value, commodities will be more expensive, and a weaker poorer India may not be able to buy / secure its share of the commodities.

Anyway, the RBI is not expected to raise or cut interest rates in today’s policy meeting.

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