Madness in monetary policy

In India we have a monetary authority that admits to not understanding inflation — but persists in damaging an already weak economy because it does not understand it

It is more than four years since my column, ‘Tell me I am mad’, (IE, June 22, 2013) was published. I had written that I found “the economic debate in India, as conducted by the RBI, professionals, and the media, extremely unenlightening. The economy has literally collapsed yet we are not looking for causes and cures.” I left it to the reader to judge whether I was mad, or the policymakers.

I repeat the challenge today. This is in the interests of a healthy debate on economic policy — we have a healthy argument on political and social policy. None of us are very deferential (nor we should be) when it comes to criticising politicians, or those making policy on such diverse subjects as the films we should not see, the beef we should not eat, the cesses we should pay, etc. No one is exempt from criticism — not the PM, not the FM, not the Chief Economic Adviser, no one. Good.

But the moment we criticise the RBI for its monetary policies, we are asked, requested, to “cut it some slack”. Writing in Mint, eminent economist Vivek Dehejia asks for restraint, given that the RBI/MPC is only doing its job, and, in his opinion, doing it well. (By implication, the others we criticise, all of them, are either not doing their job, or doing it badly). Dehejia states: “What the critics seem to be missing is that an inflation-targeting monetary policy regime, and inflation forecasting in particular, of necessity, occurs in an environment of uncertainty and long and variable lags of the impact of policy on economic outcomes, all of which conspire to make monetary policy under such a regime an exercise in minimising error, not in achieving a hypothetical optimal outcome.” (August 14).

I know it sounds confusing, and in my opinion, was meant to be. What Dehejia would really like to say is that the MPC (embarrassingly) does not have a clue as to what is going on with inflation. Which is a tragedy of large proportions because their mistaken policy of keeping interest rates high is costing the economy dear, very dear.

I wish Dehejia had been more honest. At a function in Hyderabad four years ago, former governor of the RBI, D. Subbarao said, “Most importantly we also chase monsoon like millions of farmers across the country. So, the monsoon outlook, the monsoon performance is going to be the important factor in determining the RBI policy in the next three months.”

Subbarao was honest in expressing his inability to understand the dynamics of inflation. Unfortunately, honesty about data, or inflation forecasting, or interpretation of data is not something we can “accuse” the present MPC/RBI of. Lack of an honest debate on inflation and monetary policy, is hurting India’s growth, and hurting it badly.

Quite honestly, I am tired of cutting slack for individuals when they are so, so, wrong. Proved wrong not by ideology but continuously, by their own forecasts. The entire sustained decline in inflation from 5+ levels has been missed by the RBI. Last 12 months average inflation of 3.4 per cent with the maximum of 5+ observed in August 2016. The MPC’s response: We will investigate, and write a report. Meanwhile, because of our admitted lack of understanding, we will punish the economy by keeping rates high in order to lower inflation. I ask you, who is mad?

The tragedy is that many are, and only in India. Atop the high perch of a Deputy Governor in charge of monetary policy, Viral Acharya opines: “Higher real rates are justified in the meantime as absent efficient transmission, attempts to address symptoms of balance-sheet problems with aggressive monetary easing get wasted and can even backfire by misallocating investments, fueling asset price inflation, creating false hopes of a growth boost, and relaxing the pedal on deeper structural reforms.”

This needs less translation than Dehejia’s comment but still needs some. What Acharya is saying is that high real policy rates (close to 4 per cent) are justified for 99 per cent of all borrowers so that the 1 per cent heavily indebted (balance sheet borrowers) cannot benefit from lower rates! Which they cannot — by definition. So why punish the 99 per cent ?

How different is Acharya from Subbarao in his assessment of inflation and prescription of policy? And remember, Subbarao was facing a high inflation economy, and the MPC is facing a low, deflation-prone economy — so low that the MPC is honest to admit that they don’t know why it is low, and how did we get there, but are more than willing to prescribe monetary policy that is just plain wrong. (This criticism obviously does not apply to the one MPC member, Ravindra Dholakia, who has consistently warned about the dangers of low inflation and high real rates costing jobs).

The tragedy, or madness, is that the MPC, or Acharya, are not alone in not understanding the dynamics of inflation and the importance of real interest rates. In India, but only in India, they have company. Let me relate two other pieces of evidence, and you be the judge. If I am mad, say so; equally, if others are mad, please say so.

At the release of an edited book by Rakesh Mohan, one of India’s leading economists and thinkers, there ensued a panel discussion on what policies were needed to get India growing again. The eminent panel fully recognised that the economy, particularly the manufacturing sector, was in a complete funk, and that something needed to be done. The panel rightly discussed the nature of the problem (losing jobs to Bangladesh, etc.) and discussed the exchange rate policy at some length. (But the panel did not dare note that the strong rupee may have been caused by the irresponsible MPC). They also discussed the importance of sun-spots affecting jobs; what was rather surprising is that the discussion did not involve one mention of the abnormally high RBI mandated policy rates of interest.

The median real policy rate in emerging economies is 0.8 per cent; many economies (including Bangladesh and Vietnam) have negative real policy rates. Excluding Brazil and Russia, India has the highest real policy rate in the world, and the Russian rate is only 50 bp higher. Did bad (or mad?) monetary policy not deserve even a mention?

Just a few days later after this panel discussion (and perhaps emboldened by it), Madan Sabnavis, Chief Economist at Care Ratings, authored an article in the Financial Express (August 5 ) which argued: When the problem is of demand, rate cuts don’t really help. This kind of argument is unheard of (except in India). What the (non-Indian) policy makers do recognise, and say, is that they don’t know how effective monetary policy will be in generating demand at zero, or negative real rates. But they have to try and generate demand through various other attempts to bring borrowing rates down (for example, asset purchases).

The logic, and uncertainty, that is applicable at zero or real rates is not applicable at a real rate of 4 per cent. Not appropriate when the inflation is well below target, when growth is considerably below potential, and with the RBI’s capacity utilisation estimates stuck in the low 70’s for over two years.

One of the members of the Rakesh Mohan panel was Chief Economic Adviser Arvind Subramanian who apparently was censored by the Ministry of Finance for being blunt about facts pertaining to the RBI’s policymaking. He felt constrained to say anything at the panel (on interest rates), but has opened up with a detailed analysis about what ails the RBI, and the economy.

One final question about madness: Why is it that monetary policy-makers at the RBI can delve into something outside their domain, fiscal policy, and get cheered for doing so; but when fiscal policy-makers comment on monetary policy, they are restrained from talking? The RBI is right in talking about fiscal policy; and Subramanian is equally right in criticising monetary policy. Let truth win.

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  • Surjit S. Bhalla | Ccontributing editor, ‘The Indian Express’, and senior India analyst at Observatory Group, a New York-based macro policy advisory group. Views are personal FULL BIO

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