Myopic RBI

Spinning Yarns

For the past nine months, while India has been obsessed with its fight against corruption, the Indian economy has been moving ever closer to a crisis. Economists, industrialists and heads of industry associations have been issuing warnings for some time, but these have had about as much effect as water on a duck’s back. But three near-simultaneous developments, reported within hours of each other, should force it to take notice.

First, the growth of GDP in the first quarter of 2011-12 (April to June) has fallen to 7.7 per cent. This is the first time in the past six years that, barring a brief dip at the height of the global recession in 2008-9, it has fallen below 8 per cent. The main one was a huge fall in the growth of construction from 7.7 per cent in the same period last year to 1.2 per cent this year.   

Second, the sales of passenger cars has fallen by almost 9 per cent in August. Coming after a less marked fall in July, this has more than wiped out the entire increase that took place in the first quarter of the year. Third, and most ominous, the Centre for Monitoring Indian Economy has reported a drop in new investment intentions announced during the first quarter of 55 per cent over the same quarter of last year. This estimate is especially significant because it covers not only manufacturing but the services sector as well.

Fourth, The Purchase Managers Index (PMI), which reflects the acquisition of goods and services by a sample of 500 companies, shows that in August factory output grew at the slowest rate in the past 29 months, i.e. since the bottom of the global recession in early 2008. These indicators which reinforce the trend witnessed in the index of industrial production point unswervingly in one direction: the Indian economy is slowing down, and what is more, doing so rapidly.

But the most extraordinary feature of the economic scene is the absolute refusal of the government to acknowledge that the Indian economy’s dream growth has ended. In an interview,  several days after the first quarter GDP estimate was released and, coincidentally, on the very day when the PMI hit its record low, Pranab Mukherjee stoutly maintained that GDP would grow by 8.5 per cent this year. 

But the finance minister’s optimism pales into insignificance before the utter insouciance of  the Reserve Bank. For five years, the RBI has believed that its only task is to curb inflation. Till recently I had been unable to make out whether this is because it believed that India’s growth is unstoppable or because, like the German central Bank, it believes that growth does not matter – something else is far more important. In recent months I have concluded that it is the latter. 

Seasonal supply shortages
I have been driven to this conclusion by the lengths to which it has been prepared to go in order to curb inflation. The RBI began raising interest rates in a deliberate bid to choke credit and thus  curb inflation as long ago as January 2007. It did this inspite of the fact that the price rise in summer 2006 was caused entirely by seasonal supply shortages which pushed up the prices of primary products such as  fruits, vegetables, poultry and dairy products.

Till  August 2008, it raised interest rates in every quarter, blocked credit physically to the real estate sector, pushed up the prime lending rates by nearly 3 per cent but ended with a 7 per cent higher rate of inflation of 11.5 per cent in June 2008.

 What its interest rate policy did succeed in doing was to bring the growth of industry relentlessly down from 11.5 per cent in 2006-7 to 5.3 per cent in April to June 2008. India was therefore already sliding into a mini-recession three months before the global economic  crisis began. But instead of learning anything from its misadventure (which, incidentally drove the rate of industrial growth from 11.5 per cent in 2006-7 to 8.5 per cent in 2007-8 and still lower.

One might have expected the RBI to have learned its lesson, but lo and behold, the moment global and raw materials prices began to rise again towards the end of 2009, mainly on the back of a reckless investment spree by China, the RBI once again went into its price control mode. Between October 2009 and June 2011, it raised various key interbank interest rates ten times.

Not content with that in July it raised it an 11th time by the largest amount of any single hike. These increases have had zero effect on  inflation which continues at over 10 per cent, but it has killed industrial growth.

The Reserve Bank’s obsession with raising interest rates does not stop here. While every survey made by its analysts, and quoted in the report,  admits that there has been a ‘moderation’ (decline) in demand or in the growth of demand, the RBI nonetheless cites four reasons for its decision to raise interest rates once more.

These are the overall performance of the south-west monsoon ( which it assumes will be negative); a rise in crude oil prices; further decontrol of petroleum product prices by the government to reduce subsidies; increases in other administered prices such as of coal and natural gas; and global commodity prices which it assumed would continue to harden as they had been doing throughout 2010.

Did it not strike anyone in the RBI that all these are supply side causes that cannot be affected in the slightest by making credit dearer or cutting off its supply? All that this is doing  is to replace growth-with-inflation with stagflation. In the meantime evidence is gathering that employment is shrinking. India’s vast young population, to which our dreams of overtaking China are anchored, is turning from an asset into a liability.  So who exactly is the Reserve Bank of India serving?