RBI is shooting itself in the foot over inflation

The #1 problem of Indian macroeconomic policy is the inflation crisis. From February 2006 onwards, in every single month, inflation has exceeded the target zone of four to five per cent. I’m measuring inflation as the year-on-year change of the CPI-IW (Consumer Price Index for Industrial Workers). The latter is the best measure of the overall price level in India today.  This macroeconomic instability is damaging the ability of economic agents to plan and invest for the future, because it’s hard to envision interest rates and prices when faced with such high uncertainty. High inflation thus damages growth.  Many people in India like to make excuses about inflation. One day, inflation is about the price of onions. Another day, inflation is about a global commodity shock. Many people like to open up the sub-components of WPI (the Whilesale Prices Index) and explain away inflation by saying “but it’s only concentrated in a few things which make up X percent of the overall basket”. And so on. While each of these idiosyncratic factors can generate relative price changes, they cannot explain sustained price rise of the overall household consumption basket. Sustained and persistent inflation is not an act of god. It is made by mistakes in macroeconomic policy. It can and should be contained by solving these problems of macroeconomic policy.  On 3 May, Dr Subbarao (the Reserve Bank Governor) announced a fairly good policy statement. It continued to talk about WPI while the best inflation measure is the CPI. But for the rest, it was the first time that the RBI was starting to take the inflation crisis seriously. And that was good. Also see an Indian Express column by Ila Patnaik on 6 May. Sadly, RBI’s commitment to the problem of inflation lasted for six days. On 9 May, Dr Subbarao did a speech in Switzerland which essentially robbed RBI’s stance of credibility. Ila Patnaik has a column in the Indian Express about the damage that this speech has caused. You might like to also see this old column of mine on the problems of RBI. Consider the date on which the rate hikes began. Compare two alternative worlds:• In one world, RBI says: “We care about inflation, we will do what it takes to get y-o-y (year-on-year) changes of the CPI-IW back to the target zone of four to five percent”. And the rate is hiked by 25 bps (100 bps make 1 percent). And this is repeated a short while thereafter. And so on. In this world, the expectations of economic agents get modified alongside the rate hikes. • In another world, every time RBI raises rates, RBI says “actually we are not so serious about inflation”. In this world, the expectations of economic agents do not get modified alongside the rate hikes. • Monetary policy works by directly crimping aggregate demand (e.g. driving up the EMIs that people pay (on housing loans), or the cost paid by firms for working capital) and by reshaping expectations and thus the decisions about wage/price hikes. By damaging the latter, the RBI has imposed more of the heavy lifting upon the former. What does it take for the RBI to persuade us that they are serious about inflation? Commitment to the floating exchange rate (thus removing this conflict of interest that can damage monetary policy), movement on the debt management office (DMO, thus removing another conflict of interest that can damage monetary policy), and sound monetary economics going into speechwriting (and future monetary policy formulation). By failing on all three scores, the RBI is generating a situation where there is no commitment that in the future, it will fight inflation.  Whether the RBI wants it or not, India will fight this inflation crisis, which is the #1 cloud on the horizon of India’s macroeconomic policy. The politicians require CPI-IW inflation to be back to the four-to-five percent zone by late 2013, well in time for the elections in 2014. The pressure is simply going to ratchet up. The only question is about how monetary policy will fight inflation. If the instrument of monetary policy is refashioned to fight inflation, then the amount of pain that has to be inflicted through rate hikes, that is required to get the job done, will be lower. If the instrument of monetary policy is mis-managed, then a bigger set of rate hikes are required to get the same thing done.  In the medium term, the RBI needs to build a team of top quality economists, who gain street cred by exuding knowledge of monetary economics. In the short term, the least that is required to be done is to stop the flow of low quality speeches.

Montek best candidate for IMF top job: Kaushik Basu

New Delhi: Planning Commission Deputy Chairman Montek Singh Ahluwalia is the best candidate for the top job at the International Monetary Fund (IMF), Chief Economic Adviser Kaushik Basu said today. “In my view, Montek is the best name… not only from India’s point of view, but from the world’s point of view also,” Basu told reporters here at a function to mark the golden jubilee celebrations of the Institute of Applied Manpower Research (IAMR). Ahluwalia, however, in recent interviews has said he is not eyeing the job. Reuters Ahluwalia, among others, is being talked about as a possible successor to IMF’s chief Dominique Strauss-Kahn who is locked up in a New York prison as he faces charges of sexual assault on a hotel maid. John Lipsky, second-in-command of the IMF, has taken over as acting managing director after arrest of Strauss-Kahn by the US police. Talking about the possibility of Ahluwalia taking over as the first non-US and non-European chief of the IMF, Basu said, ”I don’t know what the position Government of India is taking… 8 or 9 names that are going around. Combination of traits which he (Ahluwa ia) would take to that job… I really don’t think anyone else among the names would match up.” Besides Ahluwalia, the other candidates who are being talked about as the next IMF chief include Kemal Dervis of Turkey, Christine Lagarde of France, Trevor Manuel of South Africa and Britain’s Gordon Brown. Ahluwalia has been working as the Deputy Chairman of the Planning Commission since 2004. Ahluwalia, however, in recent interviews to media had said that he was not eyeing the job.

It’s ‘us’ versus ‘them’ in the battle for IMF top job - Venky Vembu

I was being only halfways polemical yesterday when I pitched for RBI Governor D Subbarao to be made the IMF chief following the disgraceful (near-certain) end to Dominique Strauss-Kahn’s stewardship of the organisation. But I gather from some of the responses that there are many who think the notion that a non-European would ever head the organisation is disingenuous. That’s an entirely erroneous understanding of how the world is evolving.

Yes, I know how the old order works. The rich countries got the top jobs, and us poor countries got shafted. Under that old Bretton Woods arrangement, the US and the Europe pretty much carved up the world and played monopoly. An American has traditionally headed the World Bank whereas the IMF has always had an European on top. Even today, with the hunt for Strauss-Kahn’s successor already under way, leaders in Europe are marking the territory as only fit for a European. But as Edward Hadas of the Financial Times, explains:

“This will be a turning point in the history of the IMF: European predominance, European leadership and European centre of interest will be marked as having come to an end. The power structure of the world has changed.”  Hadas emphasises that while some of this relates to the IMF’s momentary “embarrassment” over circumstances surrounding the arrest of Strauss-Kahn, that ties in with longer-term trends which are reshaping the world. “It will be very difficult for the Europeans to now claim that they have a natural right to run this institution.” So if India — or any other emerging economy — did make a pitch for the top job, the chances of getting our man in at the door aren’t as outlandish as might have appeared even three days ago. Certainly not a done deal, but not a fantasy either. The lack of unanimity among emerging countries is still a hurdle. There could be some opposition or competition from China to an Indian candidate, partly because China looks to leverage a seat at the high table for political gain — as it did when it used its clout at the ADB to block a loan to India that was to be used in Arunachal Pradesh. But in the event that India does decide to put up a candidate, who might it be? I still hold that Subbarao is a great candidate. Previous rounds of iteration have thrown up the names of Planning Commission Deputy Chairman Montek Singh Ahluwalia, but more recent speculation appears to revolve around Central Bank of India chairman S Sridhar. Then there’s Subbarao’s predecessor at the RBI, YV Reddy, the man widely credited with having steered the ship of the Indian economy through the troubled waters of the 2008 global financial crisis. Reddy too commands immaculate authority in global financial circles. All this is not to say that the power balance at the IMF, which reflects a 1940s world, will shift overnight. But know this: the old order that determined the relationship between ‘us’ and ‘them’ is well and truly dead.

Yes, we can! Let’s make Subbarao the IMF chief

In an interconnected world, the arc of history bends to connect seemingly unrelated events. And even when it doesn’t, we can on occasion bend it to our advantage. RBI Governor D Subbarao should spread his wings and heal the monetary world. We are at just such a moment following the sensational arrest of IMF’s Managing Director Dominique Strauss-Kahn for allegedly sexually assaulting a hotel maid in Manhattan. Equity and currency markets around the world are nervous as hell because Strauss-Kahn’s exit has plunged the ongoing talks to resolve the European debt crisis into disarray. Greece, that blessed country that operates in a parallel economic universe, is on the verge of a technical default on its debt, the consequences of which will have serious consequences on global markets. With Strauss-Kahn now cooling his heels in the slammer, Eurozone has lost a man who lent considerable heft to the talks to resolve the debt crisis. The IMF has named Deputy Managing Director John Lipsky to step up, but – here’s the problem – the man is already counting down the days to his retirement in August. In other words, just when the global economy needs a steady hand at the till at the IMF to calm its frayed nerves, the organisation finds itself headless — and mired in scandal. Fortunately for the world, the hour produces the man. And India can serve up just such a steady hand to head the IMF: our very own RBI Governor Duvvuri Subbarao. The circumstances for the ascension of an Indian to the top job at the IMF have never been more propitious. Just last month, British Prime Minister David Cameron, in an interview to BBC4, said it was about time the IMF looked to pick a leader from “another part of the world” (than the developed West).

“It may well be that actually when you think that the IMF has got to be listened to and taken seriously by countries not just in the West but all over the world, it may well be that it’s time to actually have a candidate from another part of the world in order to increase its standing in the world.“If you think about the general principle, you’ve got the rise of India and China and South Asia, a shift in the world’s focus, and it may well be the time for the IMF to start thinking about that shift in focus.”

Cameron was saying this principally to spite his predecessor, Gordon Brown, but why should that inhibit us? Why can’t we pay the Brits back in their ‘divide-and-rule’ coin and leverage their dissensions to our advantage? When it comes to a showdown between the Indian and the Chinese central banks over monetary policy management, the RBI knocks the People’s Bank of China out of the ballpark. The RBI is, in the assessment of internationally renowned economists, arguably the “world’s best central bank.” Indicatively, in an interview to Firstpost economist Dr Jim Walker compared the central banks in India and China.

“The RBI continues to be one of the best central banks around for monitoring the people under its supervision – which is the Indian banking system. It picks up on problems within specific banks very quickly and forces them to make specific provisions or change its risk asset weightages on property, on mortgages… In that sense, the RBI is still a model central bank. “This is the contrast between India and China. In India, we’re looking at 13-14% interest rates, which send a disciplinary signal to the private sector… The discipline of high interest means you get very high returns and the result of that usually is that a private non-financial corporate sector that can sustain their companies in downturns because they have such a high margin on their investments. You get exactly the reverse in China.”

As the man who heads the RBI today, Subbarao hasn’t hesitated to take harsh decisions when they were needed, as reflected in the RBI’s recent hike in interest rates, which beat market expectations. The IMF could do with just such a man at the top. By a confluence of circumstances, Subbarao’s services could soon become available: his term as RBI Governor ends in September 2011, barely months from now. Rather than retiring with a good book –or taking up a political appointment as a State Governor – Subbarao should spread his wings and heal the monetary world. He would make a heck of an IMF chief in other ways too. He is given to quoting Groucho Marx, mangling Chinese sayings, and quoting Latin while explaining his monetary policy approach. And to top it all, he’d never embarrass the IMF the way Strauss-Kahn did.