THE RESERVE BANK OF INDIA -Vol 4 (1981-97) - PARTS A & B
Publisher: Academic Foundation
Pages: 1,348
Price: Rs 2,195
The option of 'living with inflation' is no longer seen as an option.
-RBI Annual Report 1982-83
Reading through Volume 4 of the history of the Reserve Bank of India (RBI) spanning 1981-97, a tumultuous period of dramatic developments in the economy, was like reliving the past. This volume is of special interest to me for two reasons. First, during the period under reference I worked in RBI in senior positions in the Department of Economic Analysis and Policy (DEAP) until I retired as its Officer-in-Charge in 1993. I was RBI's coordinator with international institutions like the International Monetary Fund (IMF) during the Gulf crisis and a member of the official teams dealing with them as also of the Indian delegations to the annual meetings of the IMF and the World Bank. When we were in Washington DC in 1991, the RBI Governor left it to me to negotiate with the IMF the performance criterion for external commercial borrowing under the Fund programme.
I was also one of the authors of the Liberalised Exchange Rate Management System along with OP Sodhani and PB Kulkarni. I was a member of the Policy Group on External Debt Statistics in a two-man committee along with Y V Reddy, then joint secretary in the finance ministry.
Second, when the project to prepare the document was initiated, I was approached by RBI authorities to head the History Cell, a prestigious assignment from the professional point of view. Unfortunately, I could not accept owing to other heavy commitments.
It is possible to review this massive volume in two parts only selectively. Overall, it is a chronicle well told by a team of experienced officials with good documentation and guided by a distinguished advisory committee of experts. I only wish they had had access to the finance ministry archives also, which would have revealed the trends in the thinking in North Block. As far I can recollect at this time, during the Gulf crisis, especially when Chandra Shekhar headed a shaky coalition government with external support from the Congress, it was RBI that held fort under the courageous and far-sighted leadership of Governor S Venkitaramanan and Deputy Governor C Rangarajan supported by an A-plus team of experts. There is no adequate recognition of the contributions of those silent but competent officials. One finds a certain amount of selectivity in mentioning the names of only those who occupied relatively high positions that also perhaps reflect personal preferences of the historians. Volume 2 acknowledged the contributions of officers in the middle management levels also wherever they had made significant contributions to policy making.
How does one judge the history of an institution or a country? One can look at it from the points of view of the sins of commission and omission, that is, incorrect statements and the absence of references to important facts or events, respectively. There are a few of the second type that I could point out but have not done so here due to the space constraint. However, I could detect only one error of commission in the mention of C Rangarajan as Governor when the incumbent was Venkitaramanan (p. 454)
I restrict my remarks to monetary policy. Under the chairmanship of Sukhamoy Chakravarty, the committee to review the working of the monetary system transformed the paradigm for monetary policy. "Functions and Working", an RBI publication of July 1970, says on page 34: "….as a working rule, the rate of increase in money supply has to be somewhat higher than the projected rate of growth of real national income for two reasons. First, as incomes grow the demand for money as one of the components of savings tends to increase. Second, an increase in money supply is also necessitated by the gradual reduction of the non-monetised sector in the economy."
Breaking with the past, the Chakravarty Committee (April 1985) gave a scientific formula for the first time for RBI to plan its desired money supply to meet demand. It was one of multiplying the expected growth rate of Gross Domestic Product by the Income Elasticity of Demand for Money (IEDM) to arrive at the estimate. So far so good. But, in my view, the damage was done when it recommended an additional 4 per cent on the supply side to provide for inflation. I have called it a baker's dozen. It only assured the country of a minimum inflation rate of 4 per cent. The rationale, not highlighted in the history, was that it would reflect changes in relative prices necessary to attract resources to growth or sunrise sectors.
The committee's analytical approach was faulty. In the first place, there is no reason prices should rise in general to reflect sectoral shifts in resources. Japan is a classic example disproving the hypothesis. There was enough empirical evidence available even in 1985 to show that general inflation affected relative price variability, not the other way round, as the Chakravarty Committee assumed without any basis. I wish its attention had been drawn by the staff to an excellent paper by Stanley Fischer ("Relative Shocks, Relative Price Variability, and Inflation", Brookings Papers on Economic Activity, 2:1981). In this paper, Fischer examines extensively one of the central arguments against inflation - by distorting relative prices, inflation interferes with efficient resource allocation.
The preamble to the RBI Act makes it clear that the focus of policy should be on maintaining "monetary stability". One would think that it refers to the stability of prices, not of inflation rate, as it is being perversely interpreted now. The acceptance of the Committee's recommendation on an acceptable rate of inflation of 4 per cent, which has since become 5 per cent, was a big jump in a short period from the heroic stand of RBI cited at the beginning of the review.
Look at the damage done to the delicate monetary framework. If money supply had increased by the rate warranted by the growth in GDP and a liberal estimate of IEDM at 2 from 1984-85, M3 should have been Rs 1,734,310 crore, a quarter century later at the end of March 2009, instead of Rs 4,764,019 crore - an excess of Rs 30 trillion. It is the tyranny of the compounding effect of an acceptable annual inflation rate. No wonder the price of an apartment in Mumbai valued at Rs 3 lakh in 1984-85 has gone up to Rs 1.5 crore, at one end of the spectrum, and that of a lowly drumstick from 20 paise to Rs 10, at the other end.
The production values of the book measure up to the professional standards of the Academic Foundation. It is thoughtful of RBI to have printed the book in two parts contained in a box open on one side. Between 1970 and 2013 the annual compound growth rate of price rise of the volumes from Rs 50 (Volume 1) to Rs 2,195, ignoring the small differences in their sizes, is 9.2 per cent - even more than RBI's "acceptable" or "tolerable" rate of 5 per cent. So much for the mandate of monetary stability.
The reviewer is an Economic Consultant, Former Officer-in-Charge, Department of Economic Analysis and Policy, Reserve Bank of India, and (IMF) Adviser to National Bank of Kyrgyzstan and Bank of Sierra Leone
