1. Madness in monetary policy? Surjit Bhalla explains why that is so

Madness in monetary policy? Surjit Bhalla explains why that is so

It is more than four years since my column “Tell me I am Mad,” The Financial Express, June 22, 2013, was published.

By: | Published: August 19, 2017 5:05 AM
In India we have a monetary authority that admits it does not understand inflation—but persists in damaging an already weak economy because it does not understand. Madness?

It is more than four years since my column “Tell me I am Mad,” The Financial Express, June 22, 2013, was published. I said that I found “the economic debate in India, as conducted by the RBI, professionals, and the media, extremely unenlightening. The economy has literally collapsed yet we are not looking for causes and cures.” I left it to the reader to judge whether I was mad, or the policy-makers. I repeat the challenge today. This is in the interests of a healthy debate on economic policy, as we have a healthy argument on political and social policy. None of us are very deferential (nor we should be) when it comes to criticising politicians, or those making policy on such diverse subjects as the films we should not see, the beef we should not eat, the cesses we should pay, etc. No one is exempt from criticism—not the PM, not the FM, not the Chief Economic Adviser, no one. Good. But the moment we criticise RBI for its monetary policies, we are asked, requested, to “cut it some slack.” Writing in Mint, eminent economist Vivek Dehejia asks for restraint, given that RBI/MPC is only doing its job, and, in his opinion, doing it well. (By implication, the others we criticise, all of them, are either not doing their job, or doing it badly.)

This is what Dehejia states: “What the critics seem to be missing is that an inflation-targeting monetary policy regime, and inflation forecasting in particular, of necessity occurs in an environment of uncertainty and long and variable lags of the impact of policy on economic outcomes, all of which conspire to make monetary policy under such a regime an exercise in minimising error, not in achieving a hypothetical optimal outcome.” (August 14, 2017). I know—it sounds confusing, and in my opinion, was meant to be. What Dehejia would really like to say is that the MPC (embarrassingly) does not have a clue as to what is going on with inflation. Which is a tragedy of large proportions because their mistaken policy of keeping interest rates high is costing the economy dear, very dear.

I wish Dehejia had been more honest. As former governor of RBI, D Subbarao, was at a function in Hyderabad four years ago, when he said: “…Most importantly, we also chase monsoon like millions of farmers across the country. So, the monsoon outlook, the monsoon performance is going to be the important factor in determining the RBI policy in the next three months.” (quoted in Tell Me I am Mad). Subbarao was honest in expressing his inability to understand the dynamics of inflation. Unfortunately, honesty about data, or inflation forecasting, or interpretation of data is not something we can “accuse” the present MPC/RBI. Lack of an honest debate on inflation and monetary policy is hurting India’s growth, and hurting it badly.

Quite honestly, I am tired of cutting slack for individuals when they are so, so, wrong. Proved wrong not by ideology, but continuously by their own forecasts. The entire sustained decline in inflation from 5+ inflation levels has been missed by RBI. Last 12 months average inflation of 3.4%, with the maximum of 5+ observed in August 2016. The MPC’s response—we will investigate, and write a report! Meanwhile, because of our admitted lack of understanding, we will punish the economy by keeping rates high in order to lower inflation. I ask you—who is mad?

The tragedy is that many are, and only in India. Atop the high perch of a Deputy Governor in charge of monetary policy, Viral Acharya opines: “Higher real rates are justified in the meantime as absent efficient transmission, attempts to address symptoms of balance-sheet problems with aggressive monetary easing get wasted and can even backfire by misallocating investments, fuelling asset price inflation, creating false hopes of a growth boost, and relaxing the pedal on deeper structural reforms.” This needs less translation than Dehejia’s comment but still needs some. What Acharya is saying is that high real policy rates (close to 4%) are justified for 99% of all borrowers so that the 1% heavily indebted (balance sheet borrowers) cannot benefit from lower rates! Which they cannot—by definition. So why punish the 99%?

How different is Dr Acharya from Dr Subbarao in his assessment of inflation and prescription of policy? And remember, Subbarao was facing a high inflation economy, and MPC is facing a low, deflation-prone economy—so low that the MPC is honest to admit that they don’t know why it is low, and how did we get there, but are more than willing to prescribe monetary policy that is just plain wrong. (This criticism obviously does not apply to the one MPC member, Dr Dholakia, who has consistently warned about the dangers of low inflation and high real rates costing jobs.) The tragedy, or madness, is that the MPC, or Acharya, are not alone in not understanding the dynamics of inflation and the importance of real interest rates.

In India, but only in India, they have company. Let me relate two other pieces of evidence, and you be the judge. If I am mad, say so; equally, if others are mad, please say so. At the release of the edited book by Rakesh Mohan, one of India’s leading economists, and thinkers, there ensued a panel discussion on what policies were needed to get India growing again. The eminent panel fully recognised that the economy, particularly the manufacturing sector, was in a complete funk, and that something needed to be done.

The panel rightly discussed the nature of the problem (losing jobs to Bangladesh, etc) and discussed exchange rate policy at some length. (But the panel did not dare note that the strong rupee may have been caused by the irresponsible MPC.) They also discussed the importance of sun-spots affecting jobs; what was rather surprising is that the discussion did not involve one mention of the abnormally high RBI mandated policy rates of interest. The median real policy rate in emerging economies is 0.8%; many economies (including Bangladesh and Vietnam) have negative real policy rates. Excluding Brazil and Russia, India has the highest real policy rate in the world, and the Russian rate is only 50bp higher. Did bad (or mad?) monetary policy not deserve even a mention?

Just a few days later after this panel discussion (and perhaps emboldened by it), Madan Sabnavis, Chief Economist at Care Ratings, authored an article in The Financial Express with the following “pointer” on page 1: “When the problem is of demand, rate cuts don’t really help.” This kind of statement is unheard of (except in India). What the (non-Indian) policy-makers do recognise, and say, is that they don’t know how effective monetary policy will be in generating demand at zero, or negative real rates. But they have to try and generate demand through various other attempts to bring borrowing rates down (for example asset purchases).

The logic, and uncertainty, that is applicable at zero or real rates is not applicable at a real rate of 4%. Not appropriate when inflation is well below target, when growth is considerably below potential, and with RBI’s capacity utilisation estimates stuck in the low 70s for over two years. One of the members of the Rakesh Mohan panel was Chief Economic Adviser Arvind Subramanian who apparently was censored by the ministry of finance for being blunt about facts pertaining to RBI’s policy-making. He felt restrained to say anything at the panel (on interest rates), but has opened up with a detailed analysis about what ails RBI, and the economy.

One final question about madness: Why is it that monetary policy makers at RBI can delve into something outside their domain, fiscal policy, and get cheered for doing so; but when fiscal policy makers comment on monetary policy, they are restrained from talking? RBI is right in talking about fiscal policy; and Subramanian is equally right in criticising monetary policy. Let truth win.

The writer is Contributing Editor, The Financial Express, and Senior India Analyst at Observatory Group, a New York-based macro policy advisory group. Views are personal

  1. S
    Saurabh
    Aug 19, 2017 at 1:26 pm
    Well they've articulated their reasons in uncertainty. Anyways, they're reqd. to keep infl. above 2 over medium term. If they are over-focussing on inflation, why can't one say that u r over focussing on growth rate numbers. Also, would monetary easing only do the job? Yours might be the exasperation of someone who's not seeing things being solved at a structural level n rather expecting a "committed" RBI to ramp up GDP numbers to be able to shower praises on MODI....and yes no one should stop u from criticizing them. That's plain unacceptable.
    Reply
    1. R
      Rahul
      Aug 19, 2017 at 10:50 am
      Can't get better than this
      Reply
      1. P
        PRAKASH BAJPAI
        Aug 19, 2017 at 10:46 am
        On the one hand low rates translating to lower NIMs are bad for absolute earnings of banks. On the other it is plain politics of "Mai Baap" establishment. Lower rates by RBI may might push for small savings interest rate to be lower. This could generate an electoral backlash. High rates with various interest rates subventions give ample scope to establishment to play to the gallery. Who should cares if productive sections of economy suffer?
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        1. P
          Phani SEkhar
          Aug 19, 2017 at 8:03 am
          The choice is between low inflation, high real rates, low asset price inflation and high inflation, low real rates,and high asset price inflation only to " may be" stoke demand. So we want to emulate the developed economies and cut rates drastically with the knowledge that it will lead to asset price inflation. Would it lead to demand creation? May be!! So we should rather benefit the 1 indebted borrowers at the expense of the 99 savers along with creating an asset bubble and pat ourselves for sensible economic policy. Thank God! We still have some sane minds in the MPC who have applied brakes on asset price inflation which is causing discomfiture in some quarters.
          Reply

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