Times have changed - India's Hindu rate of growth is now the RBI rate of growth; and knowledge-proof is now RBI-proof.
Know when to fold ’em is a time-tested advice for poker, and life. And I have just decided to withdraw from analyzing the policies of the Reserve Bank of India, an institution which some claim is the only one standing tall against the onslaught of history. I am withdrawing because I have failed in all matters related to understanding the policy actions of this institution — I leave it to smarter mortals to give me, and India, wisdom.
But not without one last attempt at analyzing my inadequacies, and the failure of most commentators on the Indian scene. The reason for such abject failure is not hard to understand; the non-understanding occurred because, perhaps unfortunately, most analysts are trained to look for logical connections between word and actions. And there is a Grand Canyon disconnect between the two. In its latest words, the RBI warns us of impending doom and gloom around the world; it contends that its latest policy was set against “a deteriorating global economic outlook and heightened uncertainty about the global financial sector”. Yesterday, the IMF concurred by reducing world GDP growth for 2009 to be zero, and for India to 5.1 percent. Today, the commerce ministry warns of a loss of 1 million jobs in the export sector. If correct, this would mean the largest step-up in urban unemployment, in the quickest period of time, in our 60-year history.
The RBI also warns of deflation, and forecasts that the WPI inflation rate as of March 2009 will be 3 percent. If it is right, and there is reason to believe that the inflation figure is an overestimate, then this 12-month inflation for March will be the second lowest in the last 40 years. The lowest fiscal year ending inflation was in 2002 when it was 1.7 percent; the next lowest is 3.9 percent in March 2006.
The RBI loudly declares that it is concerned about three factors: growth, inflation and financial stability. According to its own criteria, the first two considerations suggest that the RBI should continue on the path of easing monetary policy. Financial stability considerations also suggest a lowering of interest rates, since no one has suggested (but maybe I am wrong) that financial stability in a low-inflation environment is helped by very high rates of interest.
These were the words, analysis and concerns of the RBI. What did it do in terms of policy? Zilch, Nothing, Zero. All rates unchanged. Real rates today are in the top quartile in our history, and growth and inflation way below normal, and in the bottom quartile. So now you understand the disconnect, and why one is forced to agree with a paraphrased Joan Baez Dangling Conversation:
“And we sit and make policy
Couched in our indifference
We are policymakers out of sync;
Analysis is not worthwhile
Monetary policy is really dead.”
But before leaving analysis, a final attempt at understanding the RBI. And the late Raj Krishna’s observations on Indian policymakers, made in the 1970s, still hold true today. He made two pithy observations. First, that the Indian economy proceeds along a Hindu rate of GDP growth of 3.5 percent per annum. The RBI, being with it, has updated Raj Krishna’s analysis to observing that India’s GDP growth potential, the new Hindu rate of growth, is 5.5 percent per annum. This number is easily obtained as the average rate of growth between 1980 and 2002, the year before the exceptional overheated six-year growth phase of the Indian economy. So what does make consistent RBI sense is to only ease when GDP growth falls significantly below 5.5 percent, say, 4 to 5 percent. This explains why the whole class failed in anticipating pro-active RBI policy. Further, the RBI some time ago decided to be a follower rather than leader. No point, therefore, to make policy today, when there will be plenty of opportunity tomorrow. Given this viewpoint, it also makes sense for the RBI to dispense with the scheduled quarterly review meetings. They don’t serve any purpose anymore, since the RBI is comfortable as a trader, reacting rather than acting.
One possible explanation for the RBI’s inaction is that it believes that GDP growth for India (to be released Jan 30) will be above expectations, and therefore, by not acting it can be seen to be prescient. Because of the strong deflation in the last quarter (WPI declined at a seasonally adjusted annualized rate of minus 13.5 percent), it is likely that measured year-on-year growth for the quarter will be “higher” than expected, say, at around 6.5 to 7 percent. (The same kind of difference, for the same deflation reasons, might be observed for the US, ie GDP growth to be something less negative than the deep doom forecasts of minus 6 percent for the 2008 fourth quarter). If so, the RBI can say — look, growth is so strong, we were right in not cutting interest rates! If this is the reason for not reducing sky high interest rates, ie prices falling at unprecedented rates, then my decision to fold ’em has been well-made.
There is a second observation of Raj Krishna which is applicable even today — he claimed that Indian policymakers were “knowledge-proof”. Times have changed, and the Hindu rate of growth of 3.5 percent has become the secular RBI rate of growth of 5.5 percent. And in accordance with the new reality, we should change knowledge-proof to RBI-proof.
The author is Chairman, Oxus Investments, a New Delhi-based asset management company. The views expressed are personal. surjit.bhalla@oxusinvestments.comFor an archive of articles, visit www.oxusresearch.com
