Dr Subbarao, the governor of the Reserve Bank of India, has outlined five principles for policymaking. How does he, and his ultra-hawkish monetary policy, stack up against his own principles? Let us find out.
The first principle is that “people matter”. Presumably that means that both growth and inflation matters: the latter because it hurts purchasing power, and the former because it hurts jobs. Inflation has been stuck at a high level of 8 to 10 per cent for the last six months, and that is both good news and bad news. Good that it hasn’t increased, and bad that it is too high.
On growth, the RBI’s record is not only not good, it is plain bad. Industrial growth has crawled to the slowest pace in the last 10 years (excepting the global recession months between September 2009 and October 2010), and growth in construction, where jobs and income and people really matter, has come to a standstill. According to the latest GDP data, year-on-year construction growth was just 1.2 per cent.
Second principle: when economists build models, they should fit it to the real world, and not the “real world to the models.” What reality has the RBI targeted? It alone, in the entire policy making world, utilises a monetarist model to tackle inflation. Worse, it alone uses the WPI as an indicator of inflation. If the US were to use this indicator, then it would presently show inflation at a 6 per cent annualised rate versus the 9 per cent observed in India. Given that developing countries have a 2 to 3 per cent higher inflation rate than developed countries, it does not seem that Indian inflation is that much out of line. So maybe the good doctor can tell us about whether he is living in a model world of virtual monetarism?
Third — fourth and fifth and sixth? — principles: “Economic policymaking is more than a straight application of textbook knowledge; you need to apply judgment, avoid groupthink and have a sense of history.”
History and Judgment: Subbarao’s RBI increased the repo rate by 125 basis points from 6.75 per cent to 8 per cent in the space of just 3 months. This is the second fastest increase in history, nearly matching the gallop from 8 to 9 per cent in June-July 2008. In an eerie repeat of history, at the time Dr Reddy instituted the record hikes, industrial production growth had slowed to a near zero per cent rate in August 2008, actually 1.9 per cent. According to the new IIP index, August 2008 witnessed a low growth rate of 5.4 per cent; in both April and May 2011, IIP growth was a low 5.8 per cent.
The history lesson continues. In 2008, just two months after the record hikes, and level, of the repo rate, the world economy entered a big-time slide. In 2011, at the time of Subbarao’s BMW speed hikes, the world economy is also in trouble. There was serious talk of a Euro, and European, crash. No one is raising rates anymore, and just a few days back, Brazil has actually reduced the repo rate notwithstanding the fact that inflation in Brazil is some 2 to 3 per centage points higher than the Brazilian “target” or “comfort” level.
Groupthink: RBI’s hawkishness, and policy, has been nose-led by the groupthink of several domestic journalists and many investment bank economists. The argument by these scholars has been repetitive and grossly misleading. Unlike what their peers do in other countries, these scholars have failed to note the decline in the more accurate CPI inflation (from a level of 16.5 per cent in January 2010, to a flattish 9 per cent for the last 1 year) and the fact that commodity prices are a major determinant of WPI inflation — and that the trend in international commodity prices is something they, or the RBI, can do precious little about. To reiterate, even in the very low-inflation US economy, wholesale or producer prices are up a hefty 6 per cent. Indeed, non-groupthink would dictate that Dr Subbarao take the lead of his counterpart in Brazil.
Textbook knowledge: In the non-application of text book knowledge, the RBI has made a grievous mistake, and with slowing growth, grievously is India paying for it. In recent months, the RBI has constantly been mentioning one price as a major contributor to India’s high inflation: the absolute price increases set by manufacturers of non-food items. It calls it “pricing power”. According to the RBI, this pricing power is indicated not by an increase in relative prices, but by an increase in absolute prices!
If input costs go up by 10 per cent and output prices by 5 per cent, the RBI would have us believe that there is pricing power on the part of the firm when in reality (assuming productivity and technological change to be zero) the firm is going out of business. Textbook economics would say that pricing power means at least an increase in the price of output relative to the price of inputs. According to the latest GDP data, manufacturing inflation (output prices) has stayed steady at 5.5 per cent since Jan-March 2010; the GDP deflator (input prices) has averaged close to 10 per cent. In the good overall inflation years of 2004 to 2007, inflation in the manufacturing sector averaged a higher 6.1 per cent, and GDP deflator inflation averaged a lower 4.7 per cent. One did not hear of the possibility of pricing power then.
It should be mentioned, or at least noted, that in 2008 there were strong rumours of the PMO and/or the finance ministry, dictating to Dr Reddy the July 2008 rate hike of 50 basis points. Most likely, this occurred because of a traditional misunderstanding, and panic, in these quarters about the political impact of inflation and its determinants. Something similar may have happened in the last two rate hikes of Subbarao. If that is the case, it does not say much about the “independence” of the RBI. And if that is the case, then the ban on smoking applies equally to the three sets of policymakers, and their staff, and their advisers!
The author is chairman of Oxus Investments, an emerging market advisory and fund management firm (IE)
