Column : Time to be brave, Guv Subbarao

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: We are close to reaching that point in the business cycle when the impossible trinity of macroeconomics is going to trouble a number of central banks, particularly RBI. Very simply, the impossible trinity means that a central bank cannot allow free capital inflows, keep a fixed exchange rate and run an independent monetary policy, all at the same time. It can, at best manage two, but must sacrifice the third. However, governor Subbarao, in a speech two months ago, reaffirmed RBI’s commitment to managing the impossible trinity as best as possible.

Here’s the complicated scenario that’s building up for RBI on the eve of its credit policy statement. After the glut of the crisis, there has been a massive return of foreign capital inflows, primarily into the stock markets, which is putting upward pressure on the rupee. Not unrelated to the inflow of capital into India and other emerging economies, is the decline of the dollar, which is directly linked to investors increasingly opting to move out of the safety of the dollar now that the crisis has ebbed.

Of course, the decline of the dollar is commonly viewed as good for the global economy, and it indeed is. It should help address the imbalance between massive US deficits and huge surpluses in China, Japan and Germany, an imbalance that many view as the core of the financial crisis that unravelled last year. Going into the future, the US clearly needs to consume less and export more, and China, Japan and Germany need to consume more internally. A decline in the dollar vis-à-vis the yuan, yen and euro is the smoothest way to correct this imbalance. The only hitch is whether China, which has manipulated to undervalue its currency for years, is willing to revalue the yuan. If it continues to track and undervalue the declining dollar, much of the adjustment will not happen. Worse, it will force countries like India to bear the cost of an adjustment of the US economy, a cost which we in India may find expensive to bear.