Saturday, 7 September 2013

Patience For Rate Reduction

News item, as reported in India Today dated 30-Oct-2012 - Sharp differences came to the fore between Finance Minister P. Chidmabaram and Reserve Bank of India (RBI) Governor D. Subbarao on Tuesday as the central bank stuck to its hawkish monetary stance in refusing to reduce key rates.
While controlling inflation remains uppermost on Subbarao's mind, Chidambaram is in favour of lowering interest rates to spur growth.
An upset Chidambaram said, "Growth is as much a challenge as inflation. If the government has to walk alone to face the challenge of growth, then we will walk alone."
The finance minister on Monday unveiled a five-year fiscal consolidation road map to show that the government is doing its bit to control inflation, which left headroom for the RBI to ease interest rates. However, Subbarao has not reciprocated the gesture.
"The government is doing its best to send a clear message that we are on the path of fiscal consolidation. It is my hope that everyone will read and understand the government's commitment to path of fiscal consolidation," Chidambaram explained.
Chidambaram's disappointment was quite evident when he remarked, "Sometimes it is best to speak, sometimes it is best to remain silent. This is the time for silence."

I think it’s not an easy task to fire a RBI governor who does not listen to the government. So the best answer was patience.

Our bank loan interest rates are very high. It makes me much frustrated. Reducing the interest rates brings our EMIs down, gives more discretionary income to the middle class, which goes into additional spend, boosts the economy, creates jobs, increases the growth.

The two grand old men who could do this, Pranab Mukherjee as Finance Minister and Subba Rao as the RBI governor were such boring economists, that they did and said the right things. But those were straight out of text books. And you know, what is written in textbooks are decades and centuries old principles. Being book smart is good, on the other hand what helps is being street smart. No pun intended.

Take a recent case. When Seemandhra went into agitation mode, onion prices shot up in Hyderabad to a whopping 70 rupees per kilo. Thank God, Mr. Subba Rao did not descend on to Hyderabad and announce a interest rate hike “to contain inflation.”

When we know that prices shoot up due to supply chain issues, what’s the point in keeping the interest rates high? Just beats me. Am I the only one who thinks like this?

So I googled. Fortunately I am in good company. See the notes section below for the complete references.

Sonia Gandhi and Manmohan Singh did the right things with both these god-awful politician-bureaucrat-economists. Pranab was eased into the President’s role. "You are no good executive but a long term loyalist. Hence please take on this immensely respectful but practically irrelevant role". Finance Minister to President of India, the move was straight out of organizational structure management principles.

After Mr. Chidambaram returned as the Finance Minister Mr. Subba Rao must have given him college-level-textbook-fundas. Mr. Chidambaram would have thought, what a nut guy this is and what do we do with this fellow? Of course Subba Rao was no decades old Congress loyalist. So there was no need to reward him with higher-in-name-yet-non-critical position. Just wait for his tenure to be over. “This is the time for silence.” Indeed, Mr. Chidambaram.

And Mr. Subba Rao retired. Just one phrase from my side -- good riddance. So here’s looking forward to Mr. Rajan bringing down the interest rates.

1) Shankar Acharya, former chief economic adviser to the government of India wrote in the Business Standard dated 08-Aug-2013: “As everyone knows, between the 15th and the 23rd of July, the RBI announced draconian (if somewhat opaque) monetary measures, which effectively increased the short-term policy rates by 300 basis points and sharply reduced liquidity. The measures were taken ostensibly to defend the falling rupee by restricting 'speculation.' The diagnosis was fundamentally incorrect. The rupee was not weakening due to short-run 'speculation' but because of a persisting high CAD, mounting short-term, external debt obligations and changes in the global environment for capital flows.

So the cure had little connection with the disease. As predicted, the measures did not solve the rupee’s weakness; the rupee was trading at a lower value by end July compared to July 14. Instead, these measures significantly increased interest rates across the entire term structure, curtailed credit growth for productive purposes, made government borrowing more difficult and costly, weakened the health of banks (especially government banks) and above all, further damped the outlook for recovery in output and investment.”

2) Prem Shankar Jha wrote a piece in Tehelka dated 03-Aug-2013. The title was “Our economy is staring at a deadly precipice - High interest rates imposed by the RBI have destroyed Indian industry.” He noted : “One does not even have to be an economist to conclude that the crippling high interest rates that the RBI has imposed upon the country ever since March 2010 are responsible for industry’s collapse. Other central banks, which also insisted that their governments should first reduce their fiscal deficits before trying to revive their economies, have learned the error of their ways. For example, the Japanese economy has only begun to revive after the latest of a succession of prime ministers brought interest rates down sharply a year ago. The International Monetary Fund has changed its tune and is screaming ‘reflate.’ But the RBI seems impervious to change because, a day after the release of the data on industrial production, Subbarao announced that since consumer price inflation was still running at 9.97 percent, he would continue to give priority to containing inflation over reviving growth. In other words, there would be no significant cut in interest rates. With this statement, he doused the last flicker of hope that had been keeping share markets alive in recent weeks.

The first rapid slide of the rupee began immediately after the RBI raised interest rates in its July 2011 first-quarter policy review. The decision was so perverse, to say the least, for by then no amount of self-deception could hide the fact that the Indian economy was sliding into a recession. Industrial growth had collapsed from 8.2 percent in 2009-10 to 2.8 percent in 2010-11, and the RBI had itself belatedly admitted that most of the persistently high consumer price inflation in the country was being caused by supply bottle-necks and a galloping rise in world commodity prices. Thus all that persisting with high interest rates could possibly do was to pull growth down further and trap India more tightly in a cycle of stagflation.”

3) Surjit Bhalla has been the most vocal critic of monetary policies rolled out by the RBI. He has been doing it with well informed (read data-driven) argumentation for years now. In an article “Show me the evidence” in Business Standard dated 20-Sep-2008, he stated : “It is well known that in hyperinflation economies like Zimbabwe there is a very strong relationship between money supply growth and inflation. Even there, it is not at all clear whether money supply follows inflation or vice-versa. There is most likely a third cause in operation -- a complete breakdown of the economic system and a regressive movement from a market to a barter economy. India is not, and has never been, even close to hyperinflation.

The fact remains that regardless of the measure of inflation used (WPI, CPI or the GDP deflator), real interest rates in India are among the highest (and among comparable developing and developed economies, the highest) in the world. Of course, you can get whatever result you want by mixing apples and cumin seeds.”

In another article titled “Lazy banking at its finest” in the Business Standard dated 21-Jan-2009, Surjit Bhalla wrote: “As I have documented in the past, there is a curious aspect to the Indian economic System (defined as commentators, policy makers, and academicians). The System systematically thinks in a skewed fashion, unlike any other System in the world. In particular it is trigger happy to bring the economy to a screeching halt by raising interest rates, but asleep at the wheel when the economy is in a desperate shape -- e.g. confidence at historic lows, industrial growth at zero, and exports diving over a cliff.

But the System, including bankers, cries out: Why should the government reduce interest rates, there is already so much liquidity sloshing around. But there are two aspects to ‘liquidity’ -- quantity and price. While bankers have liquidity, the same cannot be said of the borrowers. For two reasons -- first, given the reluctance of banks to lend, the borrowers are starved of funds at the prevailing (high) price of money. In addition, there is a long queue of borrowers for whom borrowing, and investing, would become more viable if interest rates were to be reduced from the astronomical (real) levels now prevailing in India.”


  1. Hey Mahboob.. I understand, you are no economist neither a student of economics.. selective criticism of RBI policies in your post do look good.. but theoretically, what RBI did was correct.. as you have rightly mentioned, it is textbook approach..

    BTW, if Governor would have taken an out of the box solution and resulted in chaos, these very people would have criticised again.. (only on other points)..
    Further, you should also know that RBI had been reluctant to raise rates initially and time n again had warned government that structural problems cannot be rectified RBI. these have to be tackled by government.. nevertheless, government did not heed to that and only followed populist policies... the result is there..
    Further, even FM tried to control expenditure, but the politics won the day, try check out additional monies sanctioned for budget in current fiscal(all demands are result of political demands)..
    There is lot more to say.. may be not the right forum..

    1. Hi Pawankumar, Thanks for your comment. Sure I am not an economist, and the nearest I came to being a student of economics is while doing my (part-time) MBA in the U.S.A. Had taken a few courses in economics.

      I don't believe in the fixation with deficits. For example, the money that is spent in MNREGA puts small amounts in the hands of a lot of people, who will spend it for their family needs that are currently not being satisfied. What I mean is such money will not cause text book inflation. It won't result in more money chasing the same set of goods.

      There are such other points that make me believe that interest rates should be cut to boost spending, help start new ventures and result in growth.