Indianomics: Is India story over?

Q: Who is to blame for the 12% inflation?

A: The word blame is not the right one. Let’s look into the causes. If you look 6 months back, it was just 4%. Oil prices had already risen, and then it became 8%, and then it began close to 12%. So you really can’t just isolate one factor. The demand side at home and the surplus flows that we have, then you create liquidity and then we issue MSS and so on trying to handle the problem. So it’s not a question of blame. There are multiple factors and some of them were unanticipated.

Q: What would you say would be the domestic factors? You spoke about capital flows, would you say that if we had proactively controlled those flows and we should have or our inability to use those flows into productive investments?

A: It is not inability. At that particular point of time, if you look at last year, if you were a dollar investor in India, you would have earned about 75% or more returns in dollar between February and December. So how do you use that kind of capital flows? But at the same time, you need FDI, you need some FIIs. You don’t have to look back, but it is just that there was this bubble, which you are seeing in the stock market. It happens in financial markets everywhere.

Q: Was the big mistake the fact that in the last five years we have not had a single steel plant come up? Land acquisition is a problem. Would you put a lot of blame on supply side?

A: If you take land acquisitions, and steel plants, they are not temporary issues. They are more structural and they have been with us for a long time. Then why do you have inflation going up from 4% to 8% to 12%? You can say expectations, and I think inflationary expectations. There were multiple factors and some of them were unanticipated, the kind where you get this sudden sharp increase.

I will not blame anyone. If I were in their position or something, the same thing could have happened because you expect things to correct themselves. Particularly when things and growth are good, it is very difficult to take measures that are harsh.

Q: So you wouldn’t say that the monetary policy was too lenient, year after year, M3 was way above 17%, the target set?

A: In retrospect, yes. There is too much of liquidity, you know it, I do and everybody else does.

Q: So the monetary policy should have become harsher?

A: Having been there as it were and handling monetary policy and so on. There is always this balance to be struck between growth, inflation and other financial sectors, stock markets.

Q: So would you justify the kind of measures taken now?

A: What I am saying is that you need to take measures on the demand side because you cannot see this kind of inflation without a demand problem or a liquidity problem. You mentioned money supply growth and so on.

The question is that you also had high money supply but with prices which were not rising at 8%. So you can get a cumulative effect. That cumulative effect is further felt by expectations if they change which happened in the case of food now in our country as well as abroad.

Q: So would you say that these measures are justified now because things have become so harsh?

A: Yes, you have to tighten money. Whether it could have been done later or earlier et cetera is difficult for me to comment.

Q: But it was needed?

A: Yes, of course.

Q: Even a 125 basis points of repo in two months is needed?

A: Not two months. Let me say again, there can be a very honest difference of view on the pace of change and on anticipation. If you had asked me for example in January, what is likely to be the rate of inflation in July, I honestly and truthfully tell you that I couldn’t have told you that it is going to 12%. Supposing retrospectively, when it was 8% even then it was difficult to say it would become 12%. Now that it has gone there, we have to be very cautious that it can go anywhere.

Q: In that case, how does monetary policy control this kind of inflation? To what extent has growth to be brought down?

A: In a problem like this we shouldn’t worry about the growth being 6% or 7% or 5% after 4 years of high growth. The drop in growth rate would have happened anyway, like through overheating or whatever you say. Your total output has increased by close to 50% say in 4-5 years. So you are going to get constraints, which is going to raise prices.

Q: You don’t worry about growth skidding off for a year. But is there a worry that it can skid off for a fairly long period. Is monetary policy capable of controlling the time element of skidding off of growth?

A: We are not dealing with monetary policy alone. This you must put in bold letters that in an economy, which is developing, which requires investment, where infrastructure is short, where you want inclusive growth, monetary policy alone is not enough. Nor is it under any circumstance by itself able to tackle the kind of issues that you have been raising. But it is a part of the whole policy package.

Q: Do you see a possibility that this can be a protracted slowdown? At the moment how does it seem to you as an economist?

A: At the moment, if it is a protracted slowdown, it’s our doing. Again if you ask me one year later who is to blame, I wouldn’t say so. There is nothing in the economic situation or the world economy, which leads to a protracted say stagflation or sluggish growth of the kind that we are witnessing like in some other countries.

But even in the worst scenario, India is likely to be one of the fastest growing countries, because the investment rate and domestic rate are high. We are not dependent on capital imports to that extent. But we have trade deficit also because of oil and we also have a physical deficit. So it is all a combination of policies that you require.

Q: So it need not be an action replay of the 1997-98?

A: No. 199-98 was a very different period. There was Asian crisis at that time. We were not strong in balance of payments. So, all the fundamentals that I am talking about out of which balance of payments is also one.

Q: So you would say that the economy now is resilient enough to not necessarily go into a protracted slowdown?

A: We have the resources. We have the ability and we have the skills to be able to handle the problem with some slowdown for a year or so until inflation comes down.

Q: To what extent can the economy slow down given the kinds of savings and investment rate?

A: People are talking about 7% now rather 9%. Some people are talking about 8%. So supposing the rate of growth comes down from 9% to 7%, then what happens? Is it something that is visible that something will happen here or there, or everywhere?

Q: Do you think it is adequate to bring down inflation?

A: I would say that today given the high priority of inflation, I would not worry about growth unless growth is non-inflationary.

Q: Is there a problem of monetary policy transmission in the first place?

A: We put in two or three other factors. One is the ownership in public sector banks; they are the largest parts of our system. They are not driven for whatever reason alone by RBI signals and so on.

Secondly, which is equally important in our kind of situations is the demand for credit, that you may want to raise interest rates but you may not be able to raise interest rates because the demand for credit is low. Credit deposit ratio is different.

So it’s all slightly more a roundabout case, about transmission lags, particularly in our country, and particularly in a period of excessive rational euphoria.

Q: If you were the Governor and you saw the frustration, the Central Bank has been raising the policy rates either CRR or repo since the last 5-6 months. It has been more pronounced in the last 3-4 months. But a similar impact or a concomitant raising of rates has not happened in the economy or in the bulk of economy, the banking sector? What can change to ensure that the Central Bank’s rate signals are implemented?

A: The Central Bank’s rate signals are also signals for not banks alone, but also for the corporate sector, the borrowers, and depositors.

Q: If you were given a choice, what banking reforms do you think are most important?

A: On the banking reforms side, my personal view is that autonomy is very critical. There will be regulatory problems or issues but they are more across the board, and we don’t put them in a situation where they have to subside.

Dr Jalan was not at his best, yet there are three key takeaways - one, he believes that the huge amount of capital flows especially late last year, is responsible for the huge inflation this year.

Secondly, he is not very uncomfortable with the level of the rate hikes this year, but perhaps a bit uncomfortable with the pace it came.

Third and most importantly, he believes that the monetary policy transmission has been clearly impeded by the lack of autonomy for public sector banks. That’s the word from the former RBI governor Dr Jalan.

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