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Tuesday, March 20, 2007

Unwise RBI Manipulating Growth Pattern

The socialist Indian government has always done this. Make a lot of noise about an economic policy and distort it beyound recognition without understanding the long term implications. And considerable damage these policies takes forever to unwind and let market force prevail to let people, individually, all 100 crore of them, decide what they want to buy and consume just like a normal economy is supposed to function.

One recent example is the sugar policy. As though buying off sugar barons will help them win UP election, without any objection from anyone, post-Punjab and Uttarakhand loss, Congress I quietly scuttled sugar price deregulations but the sops that were put in place to reduce the short term turmoil of price deregulations are being allowed to become law - further distorting the sugar market. Talk about bad coming out of a situation that was trying to do some good. And the worst part is Congress I is not going to win any additional votes by this policy. It's a distortion that nobody wants, where Congress I doesn't get anything in return, where the consumers will continue to be penalized with higher sugar prices, where the tax payers subsidy bill just went up, and where the only beneficiary are the sugar factory owners all over the country.

Earlier this week, the Agriculture and Food Ministry withdrew its Cabinet proposal to phase out government intervention in the sugar sector which had included doing away with the practice of lifting levy sugar at controlled prices.

A revised note has now been sent to the Cabinet excluding the long-term solution of gradual decontrol from April 1 while retaining the short-run relief of buffer subsidy.

And as a sop to sugar manufacturers, it introduces ocean freight (essentially export) subsidy, which, ironically, Agriculture and Food Minister Sharad Pawar had ruled out just last month. [Indian Express]

Another more pernicious market distortion - this time financial - continues at full speed under RBI. RBI manages monetary policy and exchange rate (and acts as GOI's treasury). And RBI is favoring one while talking about the other in the name of controlling inflation for aam admi. Inflation is generally caused by excess demand (leading to supply constrain) due to availability of liquidity, i.e. with easy access to credit. Beyound manipulating prices and tariffs of almost all consumed goods by our ever vigilant (of election wins and loses, that is) FM Chidambaram, thereby disrupting export orders, import plans, and sometimes, destroying businesses, RBI has talked about controlling inflation by removing liquidity from the economy by raising interest rates, among other things. Just like a distorted economy doesn't grow at full potential for very long, inflation is not budging despite all the talk and apparent action.

It turns out what RBI is taking away with one hand and it is giving back with another - for specific industries - undermining its own actions, distorting financial markets, and impacting everyday lives of ordinary people. In order to maintain its other function, exchange rate management, RBI is buying up dollars paying for it with newly minted rupees, thereby increasing liquidity in the economy. Why exchange rates needs to be baby sat is mind boggling enough. But any manipulation of exchange rate - to keep rupee weak against dollar, for example - is benefiting only the exporters. So RBI is taking liquidity away from people who have hard time accessing credit, usually the poor and small industries, and turning it into a subsidy to exporters. The liquidity in the system is still there, just unavailable for the most needy, with no impact on inflation!

Data for RBI purchases only runs till January 2007. From April 2006 to January 2007, the RBI purchased USD 12.6 billion. In other words, the RBI quietly added Rs 56,543.05 crore to the domestic monetary base. It has not been able to fully “sterilise” these dollar purchases, so money supply has gone up. The RBI then turned around and tried to take steps to suck this liquidity out of the system. These steps included raising interest rates. Many borrowers now face higher loan rates and others, especially SMEs, have little access to bank credit. [Ila Patnaik]

Exports are an important component of any country's economic growth. But any export growth has to be market driven - ie the world should consumer Indian products because they are globally competitive, not because they are subsidized by RBI. So RBI is subsidizing an American consumer, US being the largest export market for Indian goods, while punishing Indian consumer! All the while taking about helping aam admi!

RBI is killing the country's consumption led growth to promote export lead growth by distorting the financial markets. Economists consider Indian economy to be healthy because, with an economy supported by 60% internal consumption and 40% exports, it is less prone to impacts from recessions in large non-Indian economies, unlike Chinese or other East Asia economies which are largely export driven economics. RBI is distorting India's economic growth pattern and making Indian economy more vulnerable to global external factors.

Update: Suman Bery writes lot more extensively on this subject in Business Standard.

what India continues to struggle with is the familiar monetary “trilemma”: trying to reconcile an open capital account, a targeted nominal exchange rate and independent monetary policy. In the pure case targeting all three magnitudes would be impossible. But, in common with many emerging markets, the RBI attempts to square the circle by operating “intermediate” regimes all round: a semi-open capital account; an exchange rate in an undeclared band; and a “multiple indicators” monetary policy which targets narrow money, broad money, credit growth, prices, economic activity and interest rates at various moments.

Cross-posted on INI Signal