A V Rajwade: The power of monetary policy

WORLD MONEY

The sharp decline in growth in the mid-'90s was attributed to monetary policy "" will this get repeated?.

Post-liberalisation, we experienced the powerful influence of monetary policy on economic growth about a decade back. The fall in annual GDP growth from an average of 7.1 per cent over 1993-97 to 5.2 per cent over 1998-2003, has been directly attributed by many analysts to the tight monetary policy and extremely high interest rates over 1995-97. (One unanswered question: how many reasonably paid jobs were foregone by the slowdown?) For some time, two monetary variables have been adverse to investment and growth "" real interest rates are too high, and the exchange rate makes many segments of domestic industry uncompetitive with imports and in world markets. Could this lead to a fall in GDP growth as happened earlier?

There are two differences with the earlier era: interest rates are not as high, but the exchange rate then was not as adverse. But there are clearly some signs of slowdown. The index of industrial production (IIP) registered a growth of just 6.4 per cent in September, as compared to 12 per cent in September 2006. For H1 as a whole, IIP growth has slowed from 11.1 per cent last year to 9.2 per cent this year. The Confederation of Indian Industry has claimed that the IIP is not a correct representation of what is happening; that 17 sectors have recorded negative growth; and that more than 50 per cent of the manufacturing sector has recorded moderate to negative growth. Growth in bank credit and corporate profitability have decelerated and exports have grown just 4 per cent in rupee terms.

Our politicians, who are only too ready to take up the cause of workers rendered unemployed for any reason, rarely recognise the far greater potency of monetary policy in terms of slowing growth, investment and jobs. A hundred jobs lost by the closure of a factory get far more media and political attention, than a million potential jobs lost because of the wrong price of money. The positive feature of the phenomenon is that, broadly speaking, monetary policy has been left alone by most of our politicians. My worry is that the current monetary regime may well lead to one or two major factory closures (garments? diamond cutting and polishing?) and a morcha of the unemployed will attract political interest. Amongst our politicians, the leftists are generally more intellectually interested and better read than the others. The closure of a factory or two could well lead to politicians from the Left taking greater interest in monetary policy "" and exercising veto over that as well. One does feel concerned about such a development in the political economy, particularly because the leadership of the ruling party has lacked the conviction, the articulation or the skills to "market" economic reforms and policies to the people of this country. Singur, Nandigram and POSCO bring Mamata Banerjee and Medha Patkar the headlines they crave, even as our Prime Minister remains silent, unable or unwilling to argue the case for industrialisation, namely that, while, at the micro level, a proper rehabilitation package for those displaced is a must, at the macro level:

The aggregate land involved is a negligible proportion of the total agricultural land;

One acre of industrial land will produce far more jobs than an acre under agriculture;

If 60 per cent of the population is to remain dependent on 20 per cent of GDP in agriculture and related jobs, there is no way poverty can be reduced; and

Given also the need for those newly coming in the job market (15 million a year?), it is vital to encourage labour-intensive industry.

Is the fixation with keeping fiscal deficit within the budgeted number also playing a role in the exchange rate policy, notwithstanding what it might do to investment, growth and jobs? Given the way fiscal deficit is calculated, it leads to any number of anomalies:

High taxes on petro-products reduce deficit, but issue of large amounts of "oil bonds" are not counted on the expenditure side.

It seems the oil marketing companies have incurred a loss of about Rs 70,000 crore because of the administered prices; It would have been higher by Rs 22,000 crore had the rupee not appreciated since March 31. Is that the reason for allowing the rupee to appreciate, whatever its other adverse effects?

Since, in any case, oil bonds do not fully compensate for the losses sustained by marketing companies, their share prices have remained soft. What is the hypothetical loss to the exchequer were the prices of IOC, HPCL and BPCL to parallel RIL's? But then, this does not enter the fiscal numbers. In any case, how many "poor" benefit from subsidised petrol and LPG ? This apart, a huge cost is being borne by the economy to maintain the sanctity of the deficit number. Is it worth it?

avrajwade@gmail.com