Fixing monetary policy

Written by Charan Singh | Updated: Dec 10 2013, 08:54am hrs
The recent speech by RBI Governor Raghuram Rajan at Bancon 2013 is an important literary piece of art, which weaves economic thinking with sociology and presents in a lucid style the state of the Indian economy. The author of the landmark report on India, A Hundred Small Steps, Rajan delineates the challengessluggish growth in manufacturing and industry, poor infrastructure, lack of adequate education and training for youth, and weak regulatory mechanism and financial system. Finally, the five development pillars for RBI are discussedstrengthening monetary policy framework and banking structure, developing financial markets, higher financial inclusion and improving stress management in the economy. The issues raised are pertinent and deserve attention of academicians, policymakers and government.

It is interesting to note that in a developing country like India educational infrastructure has not been keeping pace with time. In India, the share of industry has declined to about 20% of GDP while that of services has increased to nearly 66%. Our population is young and ready but adequate educational opportunities are lacking. Even today, after more than six decades of planning, there are just a handful of non-engineering colleges of reputethe likes of St Stephens and Shri Ram College of Commerce. In the meantime, catering to Indian mindset, engineering colleges, including IITs, have multiplied manifold and churn out engineers in multitudes. In advanced countries like the US it is the law and commerce degree that is most sought after. Ironically, in a country with more than a billion people, the best economists are generally engineers, some from IITs, including the present Governor, Rajan.

The levels of income are rising in India and so are expectations, but absent are sufficient number of colleges and acceptable quality of educational infrastructure even for the probable problems to surface soon: illustratively, ageing. The aged population given the demographic trends is expected to increase from about 8% in 2011 to 20% by 2050. India does not have enough doctors, gerontologists and medical personnel to address the looming problem.

The issue of inflation is unique. India, which is still a developing country, with relatively under-developed financial markets and weak transmission mechanism, should not be aiming at low, even though implicit, inflation targets. There are a number of countries that already have high inflation targets, and even MIT Professor Blanchard, chief economist, IMF, has been advocating for a higher inflation target for a few years now. More importantly, psychologically, it is more frustrating to be unemployed rather than facing inflation. The present tight monetary policy has not been successful in arresting the price level because it is based on a wrong premiserising food priceswhich cannot be tamed by rising interest rates. Rather it shall be helpful to lower the interest rates and provide positive impulses through forward guidance and ushering certainty in policy path to revive growth and investment.

The way forward is difficult but possible. Governor Rajan, with his credibility, goodwill and communicative skills, can do so much and not more. But the issues flagged by Governor are of serious nature and will need solutions out of the box. The general level of infrastructure is poor in India. To build the infrastructure, we should not be shy of making special arrangements with other nations. When western countries were developing, raw material was provided mainly by colonies of the industrialised countries. In the immediate future, India neither has sufficient raw materials to build those roads, bridges, corridors and other infrastructure nor the installed capacity. In such circumstances when expectations of people have been aroused by a decade of high growth and global media penetration, tapping depressed global markets for raw materials and transporting them through idle shipping companies can be considered, rather boldly. In this context, aggressive trade agreements catering to existing gaps in infrastructure can be explored.

The government has a bigger role in undertaking more substantial reforms but probably is restricted given the looming elections. Two measures could ease the pressure on the economy though. The high duty on gold has only resulted in lower custom duties but not gold consumption, as anecdotes and eye-ball evidence suggests: smuggling has increased. It would be in the interest of current account deficit if exchange rate is allowed to adjust to market fundamentals and that would correct many woes of the economy. Also, as a country, we need to build fruitful relationships in our neighbourhood and probably explore friendship with resource-rich countries like Uzbekistan, Turkmenistan and Mongolia, if we still nurse any super-power ambitions or at least a multi-polar Asia.

Finally, it is interesting to see a formula-one driver used to ace Ferrari beginning to adjust to a rickety ambassador car. And, as the game of chess from Chennai demonstrated, the young and bold, capable of taking risks, are likely winners.

The author is RBI Chair Professor of Economics, IIM Bangalore. Views are personal