Third Quarter Review
of Monetary Policy 2011-12
AN ANALYSIS
The
RBI MONETARY POLICY REVIEWS are always full of enlightened FACTs and Figures
and are a MUST READ for every one
interested in the country’s economy .The Review on 24th, January,2012 was also
one such. It was awaited by many in the country – for several reasons.
This
Blog also had carried several articles urging that RBI must now BAT FOR GROWTH – leaving the
tackling of Inflation to the Central and State Governments – whose Onus, it
really is, in the circumstances obtaining in India.
The
Keynesian Economics works in a fully monetized economy. But, in India, there is
a huge parallel, BLACK economy (Black
money) in circulation and that thwarts all measures by the RBI to contain
Inflation. Moreover, India is also known to have huge counterfeit Notes –
possibly from some of our great neighboring countries and possibly also from
some internal sources. The rural India is largely uncovered by the banking
system in any form. But, huge spending takes place there. When we look at our
electoral battles, we clearly understand how our elected representatives fight
elections – mostly on Black money. This is a Great scourge for India – and even
the Election commissioner has pointed out this several times.
But,
what are the Bank Funds used are and how are they generated? Bank funds are the
white money in circulation (mostly) and these are used for LENDING to various
sectors, priority sectors, agricultural sector, Industrial sector and so on.
In
recent years, another phenomenon that has come into play is CREDIT CARDS –
which create TEMPORARY CREDIT in the economic system – and this generates
DEMAND disproportionate to CURRENT INCOME.
Therefore,
INFLATION in countries like India is more an interplay of DEMAND for a
PRODUCT and SUPPLY of a PRODUCT – and depends less on MONEY
SUPPLY as such. If too much of money is chasing too few goods – yes, Inflation
results. That phenomenon can be seen in stray cases – like the festive demand
season, when, tradition demands purchase of a few things in larger numbers and
traders push up the prices to take advantage of the situation.
This
apart, pushing up prices happens usually due to increase in raw material
prices, transportation costs, Taxation etc – all of which have a large element
of Government’s own actions. Price increases may also happen due to Hoarding,
lesser supply (due to lack of rains, raw materials etc ). Each product in
market has a peculiar set of circumstances – which push up its prices.
In
India, many products are Price sensitive – including basic food products.
People purchase less of tomatoes and onions also – when prices go up – and
increase their purchase, when prices come down. People don’t travel by AIR –
because of HIGH FARES. Reduce the fares, many more will travel. But Air Fares
are HIGH mainly because of FUEL COSTS determined by Govt PSUs, and TAXES of
central and state Govts. Government has not taken any positive action to bring
down these taxes and Fuel prices.
But,
in all these, INTEREST COSTS ON BANK CREDIT plays almost NO PART.
In
fact, Interest costs have not mattered much for inflation even in DEVELOPED
COUNTRIES. The irony is we see LESS INFLATION, where INTEREST COSTS ARE LEAST.
This is the world wide experience today. What pushes up prices is input costs
and supply constraints. In a competitive market of suppliers – increasing
prices is not easy. It happens, when Govt pushes up raw material costs , like
that of oil, fuel, gas, Coal, rail freight and so on, on the one side – and
uses those funds on NON-PRODUCTIVE SCHEMES like NREGS on the other.
RBI
talks of hidden inflation on Oil prices etc – but remove those subsidies – we
will see violent movements in oil prices and no one will ever know how to fix
their product prices.
These
Oil and Gas subsidies give some
stability to the economy. These make
Indian Products a little less costly than they will otherwise be – to compete
in International markets.
All
said – control of Inflation in Indian conditions rests with Governments –
through their fiscal policy actions and administrative actions.
In
my opinion – prices are not going UP or DOWN
- because of REPO & REVERSE
REPO RATES. If any thing, if interest costs go up for a producer, to that
extent, he will have to jack up his product prices. That way, the exact reverse
of what RBI is seeking to achieve happens. Also, if Interest costs to
fertilizer / pesticide companies go up -
their product prices will go up – and thereby to a certain extent, agri
commodities prices may also go up. Here
also, the reverse of what RBI seeks to achieve – may be happening. A critical
analysis of end-to-end cause and effect
sequence needs to be done – since, many factors have changed and many
new factors have come in (like CREDIT CARDS) since the classical monetary
theory.
But,
evidently, RBI monetary Policy affects Growth. In that there can be no doubt.
Capital Assets are created only - when the Return on capital exceeds the cost
of capital by a reasonable margin. Else, all the entrepreneurial effort is
considered waste. COST OF CAPITAL is directly linked to interest on the Bank
Credit. Producers at least avail Bank Credit for creation of Capital assets –
almost always. If they find Chinese Banks giving cheaper Credit, they go for
Chinese Banks. If Indian banks are giving Cheaper Credit, they go for Indian
Banks.
Thus,
Bank Credit is an important Engine for GROWTH – though its utility in arresting
INFLATION is highly suspect in present Indian conditions.
RBI
can fuel Growth in a Big way – by making cost of capital cheaper. The return on
capital depends on many factors – again the Government’s taxation, subsidy,
fuel cost policy etc come into picture in determining Return on capital.
For
example, if Airlines Industry in India needs to survive, they not only need
cheaper credit to Buy aircraft and run them, but also, lower taxes, lower cost
of fuel etc – both are needed to enable them to run efficiently and profitably.
Based
on this discussion – I welcome the CRR Cut proposed by RBI. I also welcome the
excellent logic put forth by RBI for promoting Growth. It has also indicated
albeit indirectly, the Government’s own policy requirements for Inflation
control and promoting Growth.
So,
CRR cut is a great Welcome. It provides IMMEDIATE FUNDS for all banks – and
Banks will be able to lend much more than last quarter – without raising
additional Funds. Those, who have already raised additional funds – will now
have surplus funds – and will need to aggressively go for lending – so that
they do not keep idle funds in their coffers.
But,
FUND AVAILABILITY is one factor needed for Growth. Interest Rates is an equally
crucial factor. One understands RBI’s anxiety for controlling Inflation. But,
Inflation is moving UP and DOWN – not based on bank Rates, but because of
supply factors and input factors. Also, as pointed out earlier, Countries
having least Interest Rates have very
less Inflation. This is a pointer that Higher Interest rates do not control
Inflation and lower interest rates do not fuel Inflation.
The
request to RBI, therefore – is to REDUCE INTEREST RATES SIGNIFICANTLY - and go the
whole hog in batting for GROWTH – by reducing repo and reverse repo
rates by at least 2 % - to levels where they were an year ago.
All
said – the CRR cut and the pointers in Monetary policy provide a welcome relief
to the country.
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