By all indications this is the most difficult year for policymaking since 1991. Admittedly, 1991 and 2008 are vastly different not only in terms of the nature of the problem, but also the impact on the economy and society.
Haseeb A. Drabu
Today, the macroeconomic situation is nowhere as bad as it was in 1991. Indeed, the economy has become stronger and more resilient since then. Yet the situation is more worrisome for two reasons: First, the number of policy instruments in the government quiver today is less than in 1991; second, there’s the political economy of policy action that needs to be considered. The government’s policy response is today constrained by the fact of an election in the near term. Recall, in 1991, that all measures were taken just after the general elections. In a sense, the government was unencumbered by electoral constraints and considerations.
Let us focus only on the first set of reasons. Between 1991 and now, the range and scope of economic reforms has weakened the government’s policy muscle, especially to address exceptional situations. Time and again we have seen that in the post-reform economic regime, monetary policy interventions are the only policy instruments used by the government to address short-term aberrations. Now, it is being used to address medium-term problems as well. The fact of the matter is that all other policy instruments either stand abolished or have been rendered inflexible. The ambit of larger public policy has shrunk almost in correspondence to monetary policy activism. Or perhaps it is the other way round!
At the same time, new sources of instability have come into play because of the integration of the economy, or more appropriately the financial market, with the global markets. However, new forms of policy instruments that can tackle these have not been developed. The example of moderating capital inflows is a case in point.
The problem now is that with only the Reserve Bank of India (RBI) using its monetary measures to address all kinds of situations, its policy options are shrinking by the day. How long can RBI keep raising rates? How long can it tamper with the lever of liquidity control? How often can it change the prudential norms or change risk weights?
It seems to have reached a stage now where RBI runs the risk of exposing itself. It is not just a matter of “to hike or not to hike” but to anticipate, if the hikes don’t stem the spiral, then what it would do. The situation could then get far worse. That is the call that RBI will have to take now.
It seems to have escaped most people’s notice that RBI has made the spread between the rates at which it borrows from and lends to banks widen to the highest level in its history of monetary management. At present, RBI borrows from banks at 6% through the reverse repo auction and it lends to banks at the rate of 8.5% — a spread of 250 basis points. It may be recalled that RBI’s committee on liquidity adjustment facility has recommended that the spread should not be more than 100 basis points. (A basis point is one-hundredth of a percentage point.)
It needs to be appreciated that RBI has allowed this to give itself more headroom to move either way, given the uncertainties in global markets. In situations where there are lesser uncertainties, it helps to have a smaller corridor between the repo and reverse repo rates and vice versa.
Finally, unlike in 1991, the policies seem to be getting into uncharted terrain. The manner in which oil bonds have been financed is a case in point. It may be creative but it is not correct. The oil bonds given by the government to oil companies are being financed as a private placement, off-market deal twice over: first, outside the debt market and then, off the forex market. To use foreign exchange to pay for domestic debt is maybe better than letting the country face an oil crisis, but it is not desirable. If the underlying assumptions on capital inflows and current account position are not correct, it could aggravate the situation even more.
This brings us to an extremely important part of the Governor’s statement on inflation on Monday. He said, “I call upon all market participants, in particular, the financial market participants, to appreciate the problem with the analysis at their command, participate with us in managing demand and maintaining orderly conditions in financial markets, while drawing upon the strengths of their respective balance sheets”.
This can, and should be, the turning point in India’s economic management matters. With control having been dismantled and government’s interventionist role reduced, it is imperative that market participants start playing an active role. All financial market players need to move out of the earlier mindset of only reacting to policymakers’ actions and transmit it in proportion. Instead, in such times, they need to have an independent assessment of the situation and based on that, transmit the message in an amplified or muted manner. The economic system is in a phase where the nuances and nods of policies have to be picked up and corresponding action taken. It is not the responsibility of government or RBI alone.
Haseeb A. Drabu is chairman of Jammu & Kashmir Bank Ltd and economic adviser to the J&K government. He writes on the macroeconomy. Respond to this column at firstname.lastname@example.org