Monday, June 18, 2012

RBI Mid-Quarter Monetary Policy Review: June 2012 = Good Analysis = Disappointing Decisions = Satisfies Neither INFLATION CONTROL nor GROWTH Criteria = Emphasis on SUPPLY SIDE is Forceful & Timely

RBI Mid-Quarter 

Monetary Policy Review: June 2012

RBI has released its Mid-Quarter Monetary Policy Review today. None of the expectations of the Market and India Inc are met by RBI in this Mid-quarter review. 

Very Recently Standard and Poor had downgraded India to BBB- category. Now, Fitch, another rating agency, has also moved towards downgrading the outlook on India to BBB-. It is said to be the 4th Agency to downgrade India. Can India ignore these downgrades anymore? These are a sort of CONSENSUS OPINION of all these reputed RATING AGENCIES.

The downgrade is not just an opinion for the guidance of international Investors. It is a stern advice to India – to perform – instead of giving reasons for failure. 

We, in India, are especially prone to cite, Greece, Europe, US and other nations for our Ills. That won’t do. We must look at our failures more closely. Within India, we tend to point fingers at opposition Parties, CAG, CVC, etc – for the Government’s non-performance. Indirectly, even the allies too come in as another cause for non-performance.

But, the Rating Agencies take a non-nonsense approach. Did you or did you not perform? Results speak. Not excuses.

It is in this context, that we view the RBI’s Mid-Quarter review.

If RBI’s Monetary Policy is solely, or even primarily responsible for INFLATION, it has not been able to tame the bull of INFLATION for nearly two years now, with its sole weapon of Monetary Policy. So, it has to take the Blame – and cannot shift the Blame to the Government or any others.

The implicit assumption in this argument is – that INFLATION CONTROL is susceptible to INTEREST RATE and CRR manipulation. Bank Deposits, which are part of M3 are subject to some level of control of the RBI.  But, India is not a highly monetized economy where, most money is in Banks. Most money is in fact with people, all the time. Many structural problems exist which prevent most money from entering into and staying in Banking channels.

But, RBI has huge control on “ADVANCES” to Corporates (big, medium and small scale) and Individuals, as Banks have become the primary source of such Advances to Corporates and Individuals. These advances are mostly for capital Investment related items or working capital related items – and very little relates to consumption expenditure, which is the culprit in INFLATION. So, by channeling funds to capital asset creation purposes, RBI can fuel Growth, or, alternatively, by reducing funds supply, or making the funds costlier, RBI can cut off funds for Capital Investment Purposes. It can either fuel Growth or it can curtail Growth. In my opinion, these are the two things that RBI Monetary Policies can achieve.

As for INFLATION, it is fueled by Governments in many ways, and therefore only Governments can reduce INFLATION – in the Indian context (where most money is outside Banking channels).

So, in Indian Context, it is difficult to blame RBI for INFLATION. It is also unfair to say that – RBI’s Monetary Policy is the only or fittest answer to INFLATION. At least, RBI is not solely responsible for Inflation and therefore, it cannot curb Inflation solely.

The Keynesian Economics works only when most money flows through Banking channels – not when it is in free market place where no controls exist. Well, I do understand that pure Economic Gurus will still want to see Monetary Policy working effectively - to curb Inflation in India.

Now – we will see the latest Policy Review of RBI :

RBI is strongly emphasizing the need for SUPPLY SIDE MEASURES to control Inflation. It would seem to us that unless Government initiates effective supply side Measures, RBI does not feel safe enough to reduce the Interest Rates.

The Policy Paralysis is most visible in the lack of these supply side Measures. There is a strong FOOD INFLATION – in double digits for many months. Yet, have any of us heard any fiscal or administrative measures (from central and State Governments) to CONTROL FOOD INFLATION in last one and a half years, when RBI was raising Interest Rates for curbing Inflation? 

Was there a conference of the central and state Food and Agri Ministries at Minister / secretaries levels (or both) to review the FOOD INFLATION, its causes, possible remedial measures, food items which are most susceptible for Inflation, increasing indigenous production, importing items under shortages, removing transport and other bottlenecks, improving storage facilities, improving acreage for shortage items – and such other measures – to boost supplies?

RBI was hinting at the need for supply side measures in earlier reviews too. But, they are yet to come forth. These are the need of the hour.

While the need for supply side measures needs that much of emphasis from RBI, and must be appreciated, especially in respect of FOOD INFLATION, yet, it is difficult to agree with RBI that continuance of present High Interest Rate regime is of any Use for Inflation Control.

Inflation is unlikely to respond to these High Interest Rates – as it did not in the past too – especially in the Indian Context. But, GROWTH has certainly started responding to the high interest Rates by decelerating to lower and lower levels.

It is no one’s contention, that RBI’s Rates alone are responsible for Growth levels coming down; it is basically the continued non-attention to supply side measures that is responsible for both Inflation and falling Growth levels.

RBI’s perception that –“ Notwithstanding the moderation in core inflation, the persistence of overall inflation both at the wholesale and retail levels, in the face of significant growth slowdown, points to serious supply bottlenecks and sticky inflation expectations” is largely true and indisputable.

But, it is difficult to agree with RBI’s further perception that “further reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures.” 

It will not exacerbate Inflationary pressures by itself – but these pressures will depend on the continued lack of supply-side measures mostly, as earlier acknowledged by RBI itself. 

While all statistical Info that RBI has  looked at, do reflect Inflationary pressures and decelerating Growth – its final conclusion that a cut in rates will add to Inflationary pressures now and will not support Growth – is not LOGICAL.

RBI must look at India’s  recent , say, one year experience in Inflation.

Food Inflation was going UP and DOWN with supplies COMING DOWN or GOING UP in the market place. When Vegetable or pulses supply increased in market, food inflation came down and when the supply dwindled, Inflation went up. Interest rates are nowhere in the Picture in all this.

When we look at manufactured articles, there too, demand and supply factors are playing it out in market place in a different way. Let us look at Auto sector for example. Given the price rises in raw materials and parts, there was no way that Auto manufacturers could lower prices. But, many were  and are reducing PRODUCTION. Growth was and is suffering. Inflation was and is not coming down.

Big Industries are postponing enhancement of capacities. The same thing must also be happening in medium and small sector in a bigger way. This is dangerous for future growth.

Growth is getting depressed at present and likely to get further depressed in future. This is what the Rating Agencies have also felt, while downgrading India's outlook to negative.

And, this is happening independent of Inflation – due to factors like raw Material price rises and high cost of capital.

The irony is – even while expressing serious concern about INFLATION, RBI and the Government are in a hurry to raise prices of Petrol, Diesel and Gas. The rise in prices of these basic goods will fuel an INFLATION SPIRAL, spreading to many other products and many sectors. Yes. An adjustment in their prices is needed – but only when Inflation is around 3% to 4% - not when it is hovering between 7% to 10%.

This way, with immediate increase in prices of Petrol, Diesel and Gas, the Inflationary Pressures will mount heavily and uncontrollably, across several sectors. This cannot be construed as REFORMIST. A reform must strengthen economy. This will not. Because, the timing is absolutely wrong. There should be no more stoking of Inflationary pressures from Government’s side at this point.

The TOP PRIORITIES at this point of time are three :

a.    Governments at Centre and States must not stoke Inflationary Pressures at this point of time – especially by raising the prices of Government controlled articles / products.  This should wait for a better day, when Inflation is around 4%. Let subsidies continue for some time. Heavens will not fall till such time. This will be a sound Policy for the present.

b.    Governments at Centre and States must initiate all supply side measures  - for all Inflation prone-articles – which action should be reasonably independent of the expectations from the RAIN-GOD. Waiting for RAIN GOD is not a Governmental action. Reasonable Imports, expansion of indigenous production, expansion of acreage through suitable incentives, lesser taxes at state and central levels, adequate storage  facilities and so on must be initiated quickly.

c.    Government and RBI must both resuscitate Growth in all sectors – so that India will again reach double digit Growth. This definitely needs RATE CUT from RBI so that cost of capital becomes more reasonable for manufacturers. Many Industry leaders have spoken of this in recent past.  It is also necessary to see the needs of Medium Scale and small scale Industries which will surely benefit hugely from the Rate Cut. If Indian Interest Rates are far more than that of, say, the Chinese, a measure like FDI IN RETAIL –which is often talked about, will crowd out all Indian products from Indian markets and the Foreign retailer will certainly replace them with cheaper Chinese and other products in Indian Markets. And, India will buy those cheaper foreign products, in preference to costlier Indian Products. We must make Indian Products cheaper and competitive by reducing the cost of capital.

Many Pundits frequently cite the argument of FINANCIAL INCLUSION, in which Government disburses huge sums under schemes like NREGS.

No one can be against either Financial Inclusion or NREGS – but, the only point is that - every rupee spent from the consolidated fund can not only benefit the poor, but also produce long term, useful, productive  assets for the country. 

Government must Introduce strong Productivity into these schemes. A Budget deficit arising from such productivity is worthwhile, while a deficit arising from pure doles is dangerous for the country.  The wastages in many states’ schemes are even more glaring in this respect and need to be made productive. In comparison to them, NREGS is definitely a far better scheme.

Now, Let us look at RBI’s final decisions  :

Monetary and Liquidity Measures

On the basis of an assessment of the current macroeconomic situation, RBI has decided to:
(i)                   keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.75  per cent of their net demand and time liabilities; and
(ii)                  keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 8.0 per cent.
Consequently, the reverse repo rate under the LAF will remain unchanged at 7.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at  9.0 per cent.

PS :- There is no denying the fact that every RBI review is full of enlightening facts and great Analysis. It is just that some things are beyond its control.

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