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Business News/ Opinion / Online-views/  The two values of money
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The two values of money

The ability of even the most sophisticated models to predict the future or provide reliable forward guidance is highly questionable

RBI governor Raghuram Rajan continues to attract favourable comment in the Western media. Photo: MintPremium
RBI governor Raghuram Rajan continues to attract favourable comment in the Western media. Photo: Mint

Reserve Bank of India (RBI) governor Raghuram Rajan continues to attract favourable comment in the Western media. On 6 February, David Pilling hailed him in the Financial Times as the “inflation slayer" India needs. Earlier, the paper had editorially commented (27 January) that “Mr Rajan’s decisive move has won him plaudits from foreign investors", but that “India’s currency is now back on a rollercoaster, after emerging markets were hit by a heavy sell-off last week." In fact, inflows from foreign institutional investors have been small in January and negative in the last couple of weeks; and the external value of the rupee has been quite steady, and not only in recent weeks.

And, this lower volatility is clearly due to a dramatic, and welcome, change from the not-so-benign neglect of the exchange rate by his predecessor.

In contrast, Rajan has been far more interventionist: his currency swaps with oil importers did a lot to restore balance between demand and supply. But this facility ended 10 weeks ago, and the earlier volatility has not returned. Does it mean that all is well on the external and that 62 to a dollar is a sustainable rate?

Hardly. The improvement in the trade balance over the latter half of 2013 was due to:

l Gold imports (at least in the official market) coming down dramatically, thanks both to an import duty and a fall in international prices; so have non-gold imports because of a slowing economy; even as

l Exports have risen, perhaps a lagged effect of the earlier fall of the currency.

The other side is that

l Gold smuggling seems to have gone up sharply. The World Gold Council recently estimated gold imports in India in 2013 at between 900 tonnes and 1,000 tonnes, 750 tonnes officially, and 150-200 tonnes through smuggling. The latter ultimately has to be paid for in dollars, which would otherwise be reflected in the official balance of payments; and

l Export growth seems to be slowing. And no wonder: a steady rupee in nominal terms implies an appreciating rupee in real terms given our high rate of inflation.

So we come back to the virtuousness of low inflation. As the Financial Times editorial quoted above argued, “Inflation is a significant drag on the Indian economy." Rajan seems to agree as he said in the Bloomberg interview (Mint, 31 January), “Today what is standing in the way of growth is inflation. Unless we bring inflation down, growth through lower interest rates has no hope." The crux of the Urjit Patel committee’s report is that RBI should target inflation, that too in terms of the Consumer Price Index (CPI), something like 8% (presently close to 10%) in a year’s time, and to below 6% in two years. If this is to be achieved, one apprehends further hikes in the policy rates. We should get some pointers later in the week.

Rajan has also been quoted as saying that inflation of over 6% (CPI or Wholesale Price Index?) hurts growth. I have seen the central bank’s economic analysis on the issue which is based on WPI, but have several questions. Is the number independent of global commodity prices, oil in particular? Is the only variable relevant to growth the inflation number? What about the demographics of the economy? What about the exchange rate in real terms? Surely, an overvalued exchange rate hurts domestic output?

This apart, the ability of even the most sophisticated models to predict the future or provide reliable forward guidance is highly questionable.

One recent example is that of the Bank of England: in August, it had argued that low interest rates would continue until unemployment came below 7%. Its own forecast was that this is unlikely to happen until 2016. As it happened, within three months, the unemployment rate was down to 7.1%. Perhaps, “Moderately high British inflation may have (made) the difference" (The Economist, 11 February). Surely the Bank of England has access to more reliable data than our own policymakers and still.

To come back to the editorial referred to earlier, it went on to argue that “an economy marred by high inflation is also more unequal… It is also necessary that the government narrows its large budget deficit". The other side is that research by International Monetary Fund (IMF) economists finds that a liberal capital account and fiscal compression lead to higher income inequalities. As for the former, in the same Bloomberg interview, Rajan argued that the “notion that let the prices move and let the markets adjust, then everything will be fine, is something you hear again and again. Fortunately, the IMF has stopped giving this as its mantra". The last institutional view of IMF on the subject of a liberal capital account and floating exchange rates was published in November 2011. It does not seem to suggest any material change in the ideology of the last quarter century.

This apart, while managing either price of money, we should not forget that for many years now, creation of reasonably paid jobs has been well below the number entering the job market. Again, too many of the jobs created seem to be in the form of low paid, casual employment in construction and households. In the focus on inflation-targeting, we should not lose sight of the socio-economic imperatives of this phenomenon.

A.V. Rajwade is a risk management consultant, columnist and author.

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Published: 12 Feb 2014, 05:35 PM IST
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