Governor Rajan Flatters to Deceive

Governor Rajan Flatters to Deceive

The Indian market expected growth promotion, sharp cuts in the interest rates and other measures to increase liquidity in the system from the new RBI governor Raghuram Rajan. Why? Perhaps because of the hype surrounding his international credentials, translated to mean his bias towards the West’s way of tackling a broken economy with stimulus, his considerable academic learning, and relative youth.

And perhaps because the optimists amongst us live in a fool’s paradise far removed from the Indian reality of inertia and policy confusion. Besides, one rather professorial man’s impact on an institution like the RBI, and indeed in interface with the Finance Ministry and the PMO, is, by definition extremely limited.

And besides, does the GOI really want growth at this point in its tenure? It probably does not, for two reasons. It does not want to hand over an economy partially recovered to any successor government, unlikely to be itself. And it plain does not believe that promoting growth is the only way out of its economic woes. Instead, it prefers to fight a losing battle against inflation, and resort to a number of technical and tactical moves rather than any bold strategic ones.

After all, it must be horrified by the extent of food inflation. A recent Times of India report says food prices have gone up drastically-157% between 2004, when UPA took over, and 2013, with vegetables shooting up 350% in the same period.

Onions, that tend to make and break governments in India, have shot up 521% since 2004!

Cabbages, sometimes associated with kings, have gone up a whopping 714% in the same time. Milk- is up 119%, Egg-124%, Spices-119%, Sugar-106%, even Salt is up 85%. Rice and Wheat prices have increased  137% and 117% respectively. Fruits are up 95%. And all of these are wholesale price rises, not what we pay in retail, which is very much higher.

But the stock market in its anticipation of good times, chose to ignore all this, and the fact that Rajan had always been very conservative on inflation, even a contrarian, when growth was the prevailing mantra, and the US economy was booming.

He was even mocked by officials of the US Federal Reserve for his statements predicting an impending crash due to excesses of borrowing and over-exuberant financial leveraging. Rajan became famous for being proved right then.

So true to form, conceding nothing to current circumstance, meaning the window of opportunity afforded by the US postponing its tapering of stimulus, even when some analysts felt he could have been bolder to seize the day; he let the bulls down with a thud.

Governor Raghuram Rajan,  in his first monetary policy announcements after taking over, pretty much continued his predecessor’s policy of emphasising inflation over growth and his futile, King Canute like efforts to tame the waves of price rises.

Besides there are grave concerns on non-performing assets of public sector banks- a phenomenon that goes with a slowing economy, when people find it difficult to pay back what they owe. But the answer is not to refuse to lend them any more money as the West’s efforts to stave off economic collapse has demonstrated.  

Deaf to other voices and options, Rajan has kept the policy stance of a tight rein on liquidity intact. Those sifting through the arcana of his pronouncements  concluded he actually tightened liquidity a notch leaving the  stock market observers stunned and the banking sector despairing. Others say no, pointing desperately to the marginal standing facility rate which has indeed been reduced.

The marginal standing facility (msf), an inter-bank borrowing rate, was reduced from 10.25% to  9.5%. The ‘repo rate’, a policy interest rate, was however upped by 25 basis points to 7.5%, even though Mr. Rajan sought to deflect criticism of this by calling the impact of this latter as: ‘peanuts’.

He also eased the cash reserve ratio (CRR) requirement, which is a minimum amount to be held by banks at all times to shore up their own liquidity,  but by a miniscule amount, from 99% to 95%.

Rajan made no moves whatsoever to promote growth in the economy, unless you take the above minuet as a dance, while categorically stating he would watch all aspects with a ‘neutral’ stance. The hint was that the repo rate would be tightened further in the near future, as worse quarterly economic and deficit numbers were expected.

Like Mr. Subbarao before him, it is inflation and control of the Current Account Deficit (CAD), that Mr. Rajan will focus upon. These monetary policy measures are likely to send the ‘animal spirits’ of business and industry Prime Minister Manmohan Singh referred to months ago, to the Intensive Care Unit instead. But, if the FIIs keep pumping in their near- free- from- interest stimulus money, it may be possible to ignore the RBI.

And, as before, due to the impact of this massive liquidity from the US and European stimulus programmes, commodity prices, particularly that of fuel, will see to it that these efforts at controlling domestic inflation will most likely fail.  

As for how India expects to cope with any future tapering of the US stimulus, Rajan thought various measures put in place recently will reduce the future impact. He meant that the room for spontaneous reaction domestically has been curbed. Everyone is already bound and gagged.

However, the impact on the rupee externally will have to be tackled at the time when it occurs.

Raghuram Rajan, who was welcomed for seeming very pro-growth just days ago, has left everyone confused as to the future stance of the Reserve Bank of India while his apologists say that this stance is already a departure from further tightening or the status quo.

(953 words)

September 20^th, 2013

Gautam Mukherjee