Column: Cold winds and a wet spring

Written by Meghnad Desai | Updated: Feb 3 2014, 07:12am hrs
RBI Governor Raghuram Rajan timed his interest rate hike with one eye on the domestic inflation rate and the other fixed on the US Fed. He intuited that given the timetable of Ben Bernankes departure, there was bound to be a farewell taper to set the scene for his successor, Janet Yellen. There will be a closely fought argument about the timing and the scale of the taper. But there will be a lot of bond disposals as the year goes forward.

It was interesting to see how many other emerging economies central banks were caught unawares and their currencies took a hit. For once, the rupee escaped without any effect. That tells us two things. The emerging economies are too closely tied to the Feds activities and they are neither powerful enough to shape the world recovery nor are they ready to take the counter-measures which will become increasingly necessary as the US and the UK recover. The US authorities, whether it is with monetary matters or fiscal, never take other countries into confidence or try to feel their pain. It is their economy they care about and the collateral damage their policies may inflict is other peoples problem.

This implies that as RBI gets systematic, it will have to develop a dual strategy. No doubt there will be inflation-targeting, with a band around the target rate of 4 %. There will also be measurement issues if a particular number for the target rate is to acquire totemic significance. It was Mervyn Kings great contribution to public debates when as the Chief Economic

Adviser, he made the Bank of Englands inflation measurement such an instructive exercise. Diagrams were printed in multicolour format making them attractive to read. People began to understand fan charts illustrating the confidence intervals around the central projections. Rival measures of inflation, such as the retail price index and the consumer price index, could be compared. The informed public could take part in the policy debate. The later decision to print the minutes of the Monetary Policy Committee also made the Bank more accountable as well as giving outsiders a glimpse into how experts saw and judged economic trends.

Indian authorities are reluctant to give formal independence to RBI but the UPAs policy paralysis has helped India's central bank to get its way. The transition to a new government will further aid in strengthening the de facto independence of RBI. Of course, what India needs is a fiscal target which would be adhered to. We await the interim Budget, but the news that the FM has postponed payment of certain bills to balance (or limit the imbalance in) the books, if true, is disquieting. The UK now has an Office of Budget Responsibility which monitors the data the Treasury publishes with the Budget. Something similar is needed in India. That will limit the cooking of the books which is on the cards when the Budget sessions reveal the numbers.

Yet, the real message of the last days of Bernanke is that an internal inflation target will no longer be enough. RBI will need to acknowledge the impact of global trends on the exchange rates and on the capital account. India has admirably refused to peg or dirty float the rupee. Except for a short period in the last days of the previous Governor, no specific value of the rupee has been sought to be defended. India is also more open on the capital account front than China. But that is what makes a second target more necessary. This may not be formally announced but we shall need to read the tea leaves in what Rajan does to discern the way he is going. The latest interest rate hike has a clear double message.

All the emerging economies face a turbulent time in the coming year. If the Great Recession was bad news for the developed economies, their attempts to flood the world with liquidity helped the emerging economies. Now that the developed economies (except, perhaps, the Eurozone) have recovered, the backwash will hit the emerging economies unless they defend themselves from these external shocks. One such shock could be the asset price bubbles which will come in the developed economies, especially the US and the UK.

The UK has already begun to show signs of a housing bubble. Mark Carney had promised no hike in interest rate in his forward guidance at least until 2016. This was clearly a mistake. The last Budget promised help for first-time house-buyers and this, plus a lot of hot money flooding into London, has set off the bubble. The US should also see similar bubbles when all that money lying dormant in corporate treasuries comes out and starts seeking higher returns. One can see Janet Yellen pulling back later rather than earlier given her previous record though one hopes not. In any case, it is going to be a cold, wet spring for the emerging economies as the sun shines on the rich countries.

The author is a prominent economist and Labour peer