The nation can now hope for resilience and
restoration of growth in the economy with the exit of Rajan, followed by
shifting of power of periodic review of monetary policy, to a six member
“monetary policy committee” (MPC), instead of continuing to allow the governor
of RBI to have sole discretion over it. The Modi government had to amend the
Reserve Bank of India Act in June-2016, to transfer the governor’s sole,
arbitrary and discretionary authority of periodical review of country’s
monetary policy to this yet to be constituted 6 member committee. This timely
change to take care of country’s monetary policy, in tune with the global
trend, at a time, when many countries have slashed their interest rates, to
near zero or negative to boost their growth rates, exports and investments,
would certainly enable the nation to attain requisite economic resilience. The
way Rajan has sticked to a very tight monetary policy and high repo rates,
culminating into a 12% or even higher interest rates for borrowers has caused
worst ever industrial sickness, decline in exports and a financial logjam in
economy, even when the wholesale price index (WPI) has turned negative in India
since end 2014 to felicitate a major rate cut. As a consequence of hawkish and
inflation-bashing monetary policy, characterised with high interest rates, the
investments, employment generation, corporate growth and credit off-take in the
economy have come to a near halt. Consequent negative trend in exports, growing
industrial sickness, burgeoning non-performing assets (NPA’s) of banks,
declining credit off-take and unprecedented abandonment of new projects in
pipeline have culminated as a consequence of such high interest rates in
disregard of the global trend. Almost 12 precious years appear to have been
lost by the country, under the hawkish attempts of 3 successive governors, to
scuttle growth by holding exorbitantly high interest rates, in the name of
inflation-bashing, since March 2004, when the repo rate was raised from 6 to
6.25% at a time when all major economic powers were moving in opposite
direction and are now having near zero or even negative interest rates. Repo
rate was even raised to 9% in July 2009. Now also Rajan has held the rate at
6.5% ignoring contemporary competitive global scenario.
In today’s
open and globalised economy, when goods and capital have free mobility from
across the borders, pursuing such a tight monetary policy with high interest
rates in complete disregard of the near zero of even negative or
interest rates of several countries has led the economy of Bharat to such
a state of mess. Exports have fallen straight through the last 20 months,
except in June 2016, inter alia, due to high cost of borrowings. Companies are
turning non-competitive and sick, one after the other, offering themselves as
an easy pray for takeover by foreign MNC’s due to higher interest burden.
Non-performing assets (NPA’s) of banks have peaked to turn growth in the credit
off-take from banks to negative. New projects and fresh investments have badly
dampened to the worst ever state of the post-independence period, and projects
worth Rs 8, 80,000 crores has been abandoned by most of the promoters. The loss
of output and exports suffered by the country, deprivation of youth from
getting jobs in their precious age of working and the nation’s falling behind
the other countries; not only like China, Korea and Malaysia but, even behind
Bangladesh, Philippines and Vietnam in matters of certain exports and industry
performance, is a serious cause of concern.
Indeed,
barring two short spans of high inflation viz. from March to December 2008 (for
8 months) and from December 2009 to April 2010 (for another 5 months) the
inflation had never been so high to warrant such a high repo rate. Even the
wholesale price index (WPI) has turned negative since end 2014. Yet, Rajan has
stubbornly sticked to his stance for very high interest rates regime. He has
altogether ignored the virtually zero GDP deflator in the economy, accelerating
bankruptcies in corporate sector, growing industrial sickness, in the country
out of competition from cheap imports from low interest-rate countries, import
surges of cheap goods, collapse of exports, near zero growth in employment,
burgeoning NPAs, near total abandonment of most of the project proposals,
log-jammed financial system and near halt of private investments in the
economy. Instead of conceding the reality when, company after company has been
bleeding against cheap imports and loss of export markets, largely due to heavy
borrowing costs, arising out of high interest rates in the country, he begun
alleging the industry of having greed and blamed entrepreneurs devoid of
ambition and scruple, who had borrowed heavily instead of issuing shares just
to monopolize profits and avoid dilution of control over management. On the
other hand when, as a consequence and after a year, bad loans begun to log-jam-
banking resources, due to industrial sickness, he begun to accuse bank managers
of corporate cronyism and incompetence. He had been the Chief Economic
Advisor of the International Monetary Fund (IMF), before coming to India and
joining Manmohan Singh Government as the Honorary Economic Advisor in 2008,
(and Chief Economic Advisor thereafter from 2012 and now governor of RBI since
2013) and familiar with the practices prevalent in industrialist countries.
Indeed,
growth mostly accompanies, when there is a bit of inflation. Monetary expansion
is often seen as a good means to enhance investments, employment, output, raise
per capita availability of goods and services, generate demand, raise
consumption-creating further impetus for investments, employment and demand
etc., which may perpetuate ultimate self-sustained growth. Without mild
inflation in the economy, how investments can come. The S. Korea had average
7.6 inflation throughout preceding 5 decades, yet they posted more robust
growth, by a very low interest rates regime. The inflation had even touched to
28% but, they achieved a more robust development than China, by pursing a liberal
monetary policy and low interest rate regime. The S. Korea has just 5% of our
area and population. But, it has 24% share in world ship building, while India
has less than 0.1% contribution in world ship-building, inspite of being
world’s 4th largest steel producer.
Indeed in
the course of raising repo rates since March 2004, it was raised from 6 to 6.25
and was thereafter taken to 9% by July 29, 2008. Again after bringing it down
to 4.5% by April 21, 2009, to avert the impact of down melt the rate was raised
again to 6% by September 16, 2010, and then to 8.50% on October 25, 2011. The
inflation in India had even turned negative in the end 2014, which had been so,
till July 2016 except one month of July 2016. Yet the RBI kept Repo rates at
7.75% in January 2015 and has now been holding the rate at 6.50 since April
2016, while keeping it unchanged in his last review of august 9, 2016.
One should
not forget that, in the globalised economy, the prices in India are less
influenced by money supply and more by scarcities and external variables. The
high CPI in June 2016 is due to higher food prices, wherein the pulses, prices
have shot up due to shortage in production. Otherwise also, the inflation in
India, in all these years had been high due to external variables viz-
(i) Huge
inflow of FII investments leading to higher commodity prices.
(ii) Decline
of Re exchange rate from Rs 50 per USD in 2011 to Rs 66.6 per USD in 2016,
leading to higher prices of all imports in Rupee terms, where the
imports into India are 27% of our GDP. The exchange rate of Re has fallen due
to higher trade, current account, and investment income deficits.
(iii) Poor
availability of essential items due to shortfalls in output. To improve the
supply side, a liberal monetary policy is the need of hour. Even a farmer would
dare to borrow money for farm implants and inputs for raising output, if
interest rates are low.
If the
interest rates are lowered the size of installment comes down for both
households and corporate to facilitate them to undertake expenditure and
investments respectively, to fuel growth. Monetary expansion and growth in
money supply is necessary to provide funds for investment employment
generation, consumption growth and creation of demand leading to further
investment, employment etc to perpetuate a phrase of self-sustained growth and
development.
The tight
monetary policy of Rajan and his two predecessors had little influence over
price rise due to lack of any geo-political barriers in the post globalised
economy. Due to quantitative easing (QE) by the US to the extent of USD 2
trillion after the global melt down along with the similar QE in Japan and EU
the FII investment into India has nearly trebled. Between 2001 to 2007 India
received USD 60 billion as portfolio investment, which shooted to USD 162
billion in the six year period between 2009-15, fueling commodity prices to
shoot up inflation, which the RBI tried to control by strangulating domestic
economy through higher interest rates. Likewise, when US fed reserve (Central
Bank of US) raised interest rate by just 25 basis points in end 2015 this led
to an outflow of USD 735 billion from emerging market economies (EMEs). India
also experienced a net outflow of USD 3 billion in portfolio investment in
2015-16, posing threat to the Rupee value as we had a current account deficit
(CAD) of $22 billion and it would be the safe as we could receive USD 44
billion as FDI. But, the country had to open FDI into 15 sectors in November
2015 and 9 sectors in June 2016 to sustain inflows of FDI. But, when we already
have trade and current account deficits, then continuous inflow of FDI without
matching outbound Direct Investments would worsen the balance of payments (BOP)
due to growing deficit in investment income, which is already above USD 25
billion.
Therefore,
the new governor of the RBI and the MPC to be put in place, has to evolve an
integrated approach, keeping in view the global changes while shaping the new
monetary policy. In every case the interest rates need to be reduced with
monetary easing for economic resilience, investments, employment generation and
revival of exports. Reduction in interest rates may prove vulnerable for the
senior citizens dependent on interest income. They may be safeguarded by
retaining higher interest rates for senior citizens in post office savings or
through some other special purpose vehicle (SPV) for their savings. But, India
would not be able to restore double digit growth with creation of jobs in the
economy and revive the sagging exports unless the interest rates are eased.
People may hope the new governor and the monetary policy committee to be
constituted would take care.
