The favourite whipping boy of some Indian commentators is the Reserve Bank of India (RBI). They were at it again last week. With inflation measured by the Wholesale Price Index at 11.6%, and with the government ready to undertake an advertising campaign to absolve itself of all responsibilities for the inflation problem, some experts began looking for other scapegoats to pin the blame on. A body that has no political clout is always a handy target. The most bizarre of all criticisms heaped on RBI is that it is behind times, an antiquated institution. It is time to put the record straight.
Before that, for the sake of posterity, one has to record the acts of commission and omission of this government that have landed us in the inflation mess. To an extent, some of the inflation problem is global. But, the Indian government has to shoulder considerable blame, too. Those who know economics know that, in the final analysis, inflation is a monetary phenomenon. More broadly, it is a monetary and credit phenomenon. Unfortunately, credit creation or contraction has not just been in the hands of RBI. The government liberalized external commercial borrowings several times in the last few years. It did so on occasions when RBI was raising cash reserve ratios and trying to rein in credit growth. In fact, the government acted as though it was determined to nullify the actions of the central bank.
In 2006, and as this newspaper has pointed out, even as late as January 2008, finance minister P. Chidambaram exhorted public sector banks to cut rates on all kinds of loans. If the executive thus tampers with the monetary and credit transmission mechanism, then how does the central bank curtail excess credit growth and control the inflation rate that is well above the tolerance limit?
Also, the government failed on other fronts to raise potential growth of the economy. One was its utterly brazen pro-cyclical fiscal policy. The fiscal deficit has been brought back to the levels that prevailed during India’s inglorious days. The government is behind target on the highways construction programme, power generation targets have been badly missed and not much improvement has taken place in turnaround time in Indian ports. In softer areas such as education, just four-five years of strong growth was enough to drill holes into claims of having the world’s largest pool of scientific and educated manpower. Shortage of skilled and experienced manpower is rampant, and salaries keep rising at a double-digit rate, adding both to aggregate demand and inflation.
The National Democratic Alliance government managed to privatize (not “disinvest”) several enterprises, when the Sensex merely doubled, whereas during the last four years, the Sensex leapt 400% and not a single privatization was attempted, let alone concluded. More money was poured into ailing and mismanaged public sector companies in a return to tried and failed practices.
Given this formidable track record of the government in keeping the economy bottled up as much as it could, it is somewhat strange to find the central bank being blamed for the high inflation rate.
Coming to financial innovation: Banks in Singapore, Korea, Taiwan, Japan and China have been busy writing off losses on their exposure to American mortgage-backed securities. In India, RBI largely succeeded in keeping the barbarians at the gate.
This issue of being an impediment to financial innovation is brought up repeatedly against the central bank as though it has blocked progress. At a minimum, that is highly contestable, if not outright wrong. It is not clear if some of the financial products were innovations or black boxes that simply were outcomes of loose regulation and even looser monetary policy in the early years of this decade in much of the developed world. In fact, India’s banking industry should be grateful to the central bank, for some of the leading banks in the world have written off more in the last one year than they earned in the previous five years.
As for the liberalization of the financial sector, some of its enthusiastic advocates are busy revising their views in the light of the evidence that they have uncovered themselves. To his credit, former chief economist of the International Monetary Fund (IMF) Kenneth Rogoff has been leading this reappraisal. From the IMF prescription that hailed liberalization of international capital flows as an unalloyed good for developing world, to cautioning that developing countries might have to cross a threshold to absorb its benefits, to questioning the cause and effect between the two, to observing a striking correlation between freer capital mobility and international banking crises, intellectual thought on the subject has travelled a long distance. It appears that some in India have a lot of catching up to do.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore.These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org