| No one can say that a Hindu constant is inefficiency - just look at how, despite all provocations, the RBI keeps money supply growing at a constant rate for 40 years.
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The RBI has just announced its mid-term policy on interest rates: no change. Several analysts, both before and after the announcement on January 30, were surprised at the inaction of the RBI in the face of the following factors. First, a notable decline in the growth rate of bank loans, from a 30 to a 20 per cent pace, one of the largest declines in the rate of growth since the monetary tightening of the mid-1990s. Second, the WPI inflation rate in 2007, at 3.2 per cent, is the second lowest in living memory. A flip side of this statistic is that real interest rates for most borrowers were at double-digit levels, highest again since the late 1990s (when the high interest rate regime began to change and India started to proceed towards a higher growth path). Third, the rupee (in real terms) is at its highest levels, and by a large margin, since the introduction of a competitive exchange rate regime in 1993. High real interest rates of course add to the pressure for the currency to appreciate. Fourth, the rate of growth of industrial production in India, has declined rather markedly, and, at a seasonally adjusted rate, has averaged only 6 per cent over the last six months (June to November 2007), compared to a 8.6 percent rate in the comparable period last year.
| FINDING A NEEDLE IN A HAYSTACK - VOLATILITY OF INDIAN MONEY SUPPLY GROWTH, 1990-2005 | | Country | Rank (lowest
volatility is #1) | Volatility of
M2 growth | Mean growth
in M2 | St.Dev of
M2 growth | | India | 1 | 13.50 | 15.20 | 2.00 | | Iran | 2 | 15.20 | 22.80 | 3.50 | | Bangladesh | 3 | 21.50 | 12.40 | 2.70 | | China | 8 | 34.00 | 21.20 | 7.20 | | Egypt | 13 | 36.90 | 13.20 | 4.90 | | South Africa | 15 | 38.30 | 11.70 | 4.50 | | Australia | 22 | 41.10 | 8.10 | 3.30 | | Vietnam | 24 | 41.80 | 24.90 | 10.40 | | Korea | 29 | 43.40 | 16.00 | 7.00 | | Chile | 37 | 47.40 | 15.10 | 7.10 | | Israel | 38 | 47.40 | 15.10 | 7.10 | | Hong Kong | 42 | 50.10 | 8.10 | 4.10 | | Thailand | 45 | 52.20 | 11.80 | 6.10 | | New Zealand | 60 | 61.00 | 6.50 | 3.90 | | United States | 67 | 65.90 | 4.90 | 3.20 | | Singapore | 73 | 70.50 | 9.50 | 6.70 | | Sweden | 89 | 84.90 | 4.40 | 3.70 | | Botswana | 102 | 113.10 | 13.30 | 15.10 | | Canada | 119 | 198.00 | 9.60 | 19.00 | | Malaysia | 121 | 220.10 | 9.80 | 21.60 | | Japan | 127 | 304.10 | 2.00 | 6.00 | Source: World Bank, World Development Indicators, 2007
Notes: Total of 134 countries were ranked according to the volatility of money supply (M2) growth, 1990 to 2005. Volatility is defined as 100*St.Dev (standard deviation) divided by mean growth. |
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| Fifth, even street vendors know about the distinct possibility of a US recession this year, and the fact that the US monetary authorities have decreased overnight lending rates at the fastest pace since 1982. In January alone, rates were cut by 125 basis points. Sixth, the stock markets around the world were witnessing the largest January declines, again in living memory. The Indian stock market was down between 15 and 20 per cent, about average for most stock markets.
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| Given these facts, there was an expectation that interest rates would be eased somewhat by Dr Reddy. Even the governor acknowledged that interest rates were high in India, and admonished the banks to decrease their lending rates. Given no change in interest rates, the markets (and most economists) were genuinely surprised at the RBI's rather rigid stance.
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| But we shouldn't have been surprised. Practically the whole class failed. We were all looking at the wrong data. What we should have known is that Dr Reddy, along with his mentor, Dr Rangarajan, is not just a monetarist, but a very pure and strict monetarist. If only we had looked at the rate of growth of money supply (M2 in economist jargon, M3 in India) we would not have been surprised. Some decades ago, the inimitable Raj Krishna had coined a phrase to describe the lethargic and pitifully low rate of growth of the Indian economy in our practicing socialism decades of 1950 to 1970s. This low constant rate of GDP growth (3.3 per cent per annum) was termed the "Hindu rate of growth".
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| Indian monetary policy is another constant, even more unwavering than the northern star. For the four decades since (and including) the 1970s, M2 growth has averaged 15.9 per cent per annum. The individual decade averages: (1970 to 1979) 15.9 per cent, 15.8 per cent, 16 per cent and 15.7 per cent (2000 through 2007). The decade averages for GDP growth: 2.8, 5.7, 5.5 and 6.3 per cent. Two points are of note from this simple average calculation: first, that money supply growth was the lowest at a time when GDP growth was the highest. For the last five years, GDP growth has averaged 8.6 per cent per annum, and M2 growth only 16.1 per cent.
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| Perhaps Indian monetarism is normal among countries, developing or developed. For a verdict on that, one has to look at the data, and the table provides for selected countries, the average rate of growth of money supply, and the standard deviation of this growth for the period 1990 to 2005. A total of 134 countries are ranked according to the volatility in money supply growth (given as the ratio of standard deviation to mean). The land of the Hindu constant ranks first, and does it. Our volatility is a paltry .135, i.e. for each 1 per cent growth in money supply the volatility is only 0.14 per cent. Close on India's heels, but still with 10 per cent higher volatility is that other well managed monetarist economy, Iran. Number 3 , and with 60 per cent higher volatility, is Bangladesh. China is ranked 8th but with money supply growth volatility that is more than two and half times that of India. Korea is 29th, and Hong Kong is ranked 42nd. The US is ranked 67th (volatility five times India) and Japan is ranked 127th (volatility more than 22 times that of India).
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| It is interesting to note that in the worldwide macroeconomic data that the IMF puts out biannually, the World Economic Outlook data, there is not a single data series pertaining to money supply! Yet it is the most important monetary policy variable for the Indian monetary authorities. It appears that along with communists, monetarists have found their home in hospitable India. But to get a proper sense of what this really means in a comparative sense, think how the Indian economy would be if it were to be ruled by Prakash Karat?!
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| Raj Krishna is perhaps more known, and more perceptive, with his other quip: Indian policy makers were "knowledge proof" (circa 1970). Times have changed, the world has changed, and according to most observers, even the Indian economy can grow, in non over-heated mode, at 8 per cent plus. Yet there is one institution that has not changed in its conduct of monetary policy "" the RBI. One only has to look at the RBI to know how efficient India can be "" we can keep money supply growth at the same constant level for 40 years!
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| But there is a silver lining "" India has ceased to be an economy where the politicians, or bureaucrats, can do damage. They can help, with forward-looking policy, to help India grow at its potential of 10 per cent. But they can hurt no more.
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| The author is Chairman and Managing partner, Oxus Investments, a New Delhi based asset management company.
surjit.bhalla@oxusinvestments.com |
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