Monetary Policy - Inflation - Growth - What must RBI be doing instead of its efforts to control Inflation - And why?

Monetary Policy, Inflation, Growth

For the last several years, chiefly for the last 3 years, I have been a keen watcher of RBI’s monetary policy declarations. I always admired the analysis by RBI of the Micro and macroeconomic environment within India and outside. A lot of Economic Variables are analyzed by RBI with great insight.

Having acquired a masters in Economics myself over 35 years ago, and since then, following the economics of the country reasonably, I was always interested in the economic analysis documents of the RBI and of the Government.

The one thing that always dismayed me for several decades now – is the near total disjoint between the States’ economic Policies, the Centre’s economic Policies and the monetary policy of the RBI.

The State Governments, at least many of them , are economic illiterates and squanderers of Good Public money after bad economic Policies. The greater tragedy is – that people reward them with Votes for this profligacy. India will become better when this economic profligacy stops – or, is stopped forcibly – by the people. When a Government distributes Dhotis, saris and such other unproductive freebees, instead of helping to create Jobs and productivity with public money – people should vote them out.

Now, the Central Government has turned just as bad as this in recent years, mainly due to coalition Politics. As economics says, the bad Coin has driven out the Good coin – at the centre too.

The intention of this Blog Post is not examine these aspects of economic policy in detail but to focus on the failure of RBI’s Monetary policy.

For about 2 years now, this blog has been expressing serious doubts about the efficacy of Monetary Policy in India in controlling Inflation. 2 days ago, I saw an article on just about the same lines in a leading economic news paper. This monetary policy of adjusting repo and reverse rates and thereby hoping to control Inflation has not worked anywhere and is not going to work in India especially.

Even in countries where it seems to have worked, what has exactly happened, seems to be - that the Government’s supply side measures and price control measures have worked in controlling Inflation and succeeded in some measure; but, at the same time, the monetary policy measures were also in place – making it seem as though the monetary Policy has somehow contributed to the control of Inflation. But, in reality, monetary policy measures have very little effect of control on Inflation.

In India, food Inflation is the major component of overall inflation, followed by Oil and gas prices (or administered prices). Both are not susceptible to any influence of the repo and reverse repo rates. This blog has stated this very often in last 2 years. But, it is only in the last 2 months that RBI also has indicated this in its policy statements.

Let us face the facts. Repo and reverse repo rates have no direct influence on Prices of any commodity on earth. All that these can do is, to make the Bank lending dearer (or cheaper), that too, on a broad-based manner and not in a focused manner, though the latter is also possible but never attempted.

Precisely for this reason, food Inflation is absolutely beyond any Influence of the Monetary Policy of RBI. If anything, RBI’s monetary policy seems to work diametrically opposite to its intention.

When lending rates go up, the indisputable possibility is - lending for agricultural inputs, like fertilizers, seeds, tractors, other agri implements and inputs also suffer rise in prices. Agri lending is priority sector lending in our country and this lending rates (interest costs) go up immediately - due to rise in repo rates. Consequently, the prices of all final agri products like pulses, sugar, fruits, vegetables – will go up directly due to the Monetary Policy. But, the intention of the Policy is to – reduce the prices of these final agri products.

It is therefore a EUPHEMISM to state that RBI policy does not affect Agri products and food Inflation. No. The Policy affects these prices; but in exactly the opposite direction to its stated intention of reducing the prices of agri products. RBI Policy seems to contribute to increase in agri prices and Food Inflation, instead of reducing it. 

But, to be fair to RBI, the Greater villain in the rise in prices of Agri Products is the lack of supply side measures from the central and State Governments and lack of price control measures on  at least essential commodities. It is painful to see the prices of some essential commodities racing up to 1000 % of their normal prices and yet the Governments not acting at all.

The second aspect of Inflation is prices of certain commodities like oil and gas that are directly fixed or influenced by the Central and state Governments. Frankly, oil and Gas need not be at these Price levels in India. The centre and the states must reduce the huge tax burden on these commodities. These are base products in the economy - the prices of which determine the prices of all other commodities and services in the economy. Their price rise has a huge spiraling effect  across the board. Therefore, I feel that all taxes on these base commodities are in fact - reflective of our economic illiteracy and economic profligacy. It is always the final and intermediate commodities that should be taxed and not the base products.

The whole concept of GST and other newer ideas of taxation are based on the concept of avoiding double taxation. If Oil and Gas are taxed as heavily as in India by the Centre and states, the economy is bound to be ALWAYS STRESSFUL and always UNCOMPETITIVE vis a vis the Chinese and other economies where these are either not taxed or taxed much less than in India. Indian products and services will remain uncompetitive and will become more and more uncompetitive with these huge taxes on Base commodities.

Coming back to monetary Policy, RBI was always advising Government to reduce subsidies on oil and Gas. Instead, it should have advised Government to reduce the taxes on these items. If the taxes come down, the withdrawal of subsidy will not affect the common man as the prices will come down to healthier levels. After all, what is subsidy? Subsidy is also the amount paid by common man in taxes and collected by Government - but, which is later used by Government to reduce the prices of oil and gas – which all common men Buy. This "take First and then Give back" in different form – is meaningless economics. Subsidy is public money collected in taxes which is given back to public again indirectly as reduction in prices of oil and Gas. The whole effort is a waste of time and energy. Let the taxes come down and let the subsidy also come down. RBI’s effort must be directed to persuading both central and state governments to do this. It is only then that the prices of these commodities really reflect international prices.

How and where does the RBI’s monetary Policy really affect the economy? Why? Obviously, it is in the lending activity that happens at Bank counters -to the various sectors of the economy.

We have already seen how it affects Agri sector – in exactly the Opposite direction to RBI’s intention.

The other major sectors to which lending happens is - for production, expansion and consumption.

In respect of Production :– by now, it is crystal clear that Auto sector – 2,3,4 wheelers of all types – is facing demand slow down. Likewise, many consumer durable products are facing sluggish demand. This is clearly not the sign of a healthy economy. Housing construction is booming but demand is tapering off – partly due to the avaricious prices set by the developers. Auto, consumer durables and Housing are the major sectors financed by Bank lending. When lending rates go up, demand comes down. Production too comes down. It is happening. It is there for all to see. Again, both these aspects are not healthy for the economy. But, where are the prices coming down in any of these sectors? Do any of us see any prices coming down in any of these products?Repo rates are increased by RBI for this purpose but that is not happening.

Banks have seriously burnt their fingers in lending to Infrastructure (roads, dams, bridges etc), Power Generation and distribution sectors. Now the Banks are – once burnt-twice shy. So, Infra sector needs lending but lending is not happening. Already lent money is finding it difficult to go back to lending Banks. Here also, favourable government policies could have averted this.

So, where and how any prices can come down due to the raising of the repo rates? These Keynesian economic theories (On monetary Policy) depend on a whole lot of assumptions and presumptions – none of which seem to exist in India.

What can effectively bring down prices of final commodities is supply side measures and administrative monitoring and controls. That is not happening to the extent needed. Hopefully, a newer government in Apri-May may be more effective in this aspect. At least, the electorate must make a strident demand for control of prices – as an Election Issue.

Consumption :- Consumption also suffers only in these sectors because lending for consumption also is mostly happening in these sectors only. Thus, production and consumption are both suffering in Auto, consumer goods and Housing sectors due to monetary policy – but still prices are not coming down – as they depend on many other variables too.

Expansion, or, creation of fresh capital assets:- Currently, demand from Industry for new installation and expansion is not seen at all at bank lending counters! Many Bank managements have said this for several quarters now. This must be the most worrying point for Banks, RBI and Governments. This must also be seen in the context of Manufacturing indices showing either negative growth or insignificant growth in most months in recent past. This must also be seen in the context of rising NPAs in many Banks – chiefly PSU Banks, which have (of course rightly) lent huge monies to manufacturing and infrastructure sectors in the hope that government and RBI policies will support these sectors. But, these are the major sectors which are now failing and giving rise to huge NPAs.

RBI has of course issued several instructions to Banks to avoid lending to companies which are likely to fail; and to collect dues by all means from defaulter companies. But, the failure in many cases is occurring due to absence of favourable Government Policies and partly due to Huge interest costs , which is due to High repo rates. Every Month, Government must review the NPA sectors and see what ails these sectors and why they are becoming NPAs. These companies must be supported by Government action.

In the final analysis, the monetary Policy action, in my personal view, is directly affecting growth – while not having any positive impact on Inflation.

If ever they could affect Inflation, they would have done so in last 3 years when RBI was consistently raising repo rates. The plain fact, in my opinion is, they can affect growth but they can’t affect Inflation.

If Inflation can at all be influenced positively by rising Repo rates, why not raise the rates by 1% instead of 0.25%. Or even by 2% - to see if it at all has a beneficial impact on prices. It won’t. Only Governmental action and natural supply-demand forces can control Inflation. Presently also, only natural supply-demand forces are acting on Inflation but are weak now. If ever in future, Governments at centre and states swing into pro-active action, then, there will be effective control on Inflation. Until then, we must pray God! That is - pray that natural forces be favourable to us - since, only natural forces are acting now - and not Governmental measures.

RBI, on its part, can drastically reduce repo and reverse rates – though gradually – so that growth will pick up and the danger signals in the manufacturing sector will recede.

The oldest assumption is – ECONOMISTS DIFFER. I differ from RBI. All the above is purely my opinion. RBI, in its wisdom, differs on all this and perhaps, it differs from Government's opinions as well. Government differs from media. Media differs from all the above. Inflation differs from and defies all of us and likes only the natural forces of demand and supply. We will be successful when we create the favourable natural forces.

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