A complicated re-telling

Written by Saumitra Chaudhury | Updated: Jan 21 2002, 05:30am hrs
The Reserve Bank of Indias Report on Currency and Finance 2000-2001 is not easy reading, especially if one has to read it off the RBI website. One sympathises with a financial paper that led with the story that in this years RoCF, the RBI put the blame for the current slowdown on low inflation and a small current account deficit! Is this a misrepresentation of what the RoCF said Well, yes and no. And that is the real problem with this report it celebrates the two-handed economist in rather unrestrained fashion!

In the concluding section in the chapter on Growth, Inflation etc, the report states that in the Indian context: Threshold inflation, ie, growth-maximising inflation rate is estimated at 5 per cent. There are potential output losses involved in further disinflation. (5.76). Further, in the concluding observations of the final chapter, the report states that, (T)he pursuit of controlling inflation below the threshold as an objective of monetary policy has adverse output consequences. In India, sacrifice ratio the output costs of disinflation, can go up to 2 per cent of real GDP for every one percentage point reduction in inflation. (8.42).

But dont jump to any conclusions. Nowhere does the RoCF actually say that this has indeed been the case. Nor does it define the measure of inflation that it regards as appropriate wholesale prices, consumer prices or the implicit GDP deflator. Well, you could argue that with WPI inflation at 2 per cent, there is, a 5-2=3x2=6 percentage points loss of growth; just because of low inflation, we have a growth rate of 5 per cent, instead of 11 per cent! But, of course, that would perhaps be plain wrong. For one, consumer price inflation is at 5 per cent, that is, equal to the growth-maximising inflation rate, and the quarterly GDP deflators are between 4 and 5 per cent. So, actually what we are getting is what we could get! And for another, these things may look simple, but that is one thing that they are not.

Now, coming to the Current Account Deficit. In the concluding comments on foreign capital flows, the RoCF does state that: The conservative approach to sustainable level of CAD needs to be reassessed in the light of the changes brought about in the 1990s in the composition of capital flows in favour of non-debt creating liabilities. Loosen up Not quite: The extent of dependence on external financing cannot be raised significantly without endangering the risk of payments difficulties. (6.55) Anyway, one thought the RBI has been reviewing its position vis-a-vis the current account deficit on a continuing basis, what with abolition of QRs and other changes in the foreign exchange management regime. From reading the report it might seem to some that the RoCF endorses, from a prescriptive point of view, the Tenth Plan papers arithmetical conclusion of a 2.8 per cent CAD required (in order to achieve the required investment rate to achieve 8 per cent GDP growth). But not really it depends on export performance: The sustainability of the growth process would critically hinge upon the export performance during the Plan period. (6.53).

On foreign capital inflows, it was surprising to note that a fairly obvious point was not made. Foreigners, just like domestic businesses, invest where they think they are reasonably sure of making an adequate profit. So they invested in coloured soda water, automobiles et al. They did not think that they would make money out of roads and ports, so they did not invest in these, despite the urging. Some of them thought (quite incorrectly) that they would make money in power;others have quickly learnt the lessons. Telecommunications look attractive, so foreign capital has been laying it on thick. Insurance they think is promising, as perhaps is banking, retail and real estate. So what is our policy response Permit 100 per cent foreign ownership in ports and the like, where nobody is interested. Restrict ownership to 26 per cent or whatever, where foreigners are interested. And we wonder why FDI inflow into India is small Or as the RoCF states Growth-inducing properties of external capital flows have remained unexploited due to lack of absorptive capacity.(8.43).

With similar jumbo-sized and a largely poor population, with a common history of some version of central planning and control, should we not examine the Chinese experience China is the preferred FDI destination, the fastest growing economy in the world, has zero inflation and current account surpluses. Has Chinas remarkable monetary and exchange rate stability been behind her success in attracting huge FDI But China finds no mention. In closing, the RoCF fires a few other salvos:High incidence of unemployment and lack of tangible gains in poverty reduction. Seemingly, the RoCF is dying to get into every controversy in sight, and with a pre-judged position!

Saumitra Chaudhuri is economic advisor to ICRA (Investment Information and Credit Rating Agency) and editor of Money and Finance, the ICRA bulletin