Rajeev Malik: RBI versus the spin doctors

The RBI deserves more credit than it gets for the far more accurate and non-consensus reading of the local and global economic cycles.

An interesting feature of India's economic rise and the recent unprecedented bull run in asset prices has been more frequent commentaries in the press on the state of the economy, and on the assessment and recommendations for the broader policy framework. The impressive variety of opinions and suggestions has been useful, and has enriched the public debate over economic issues that until just a few years ago were mainly in the domain of opaque policymakers and a few others.

Indeed, economic issues have become so talked about that one could be forgiven for being mistaken that almost everyone is a macroeconomist these days. Never mind that some columnists continue to unwittingly confuse near-term options and the adopted policy response with long-term development goals.

Unaccountable, free and uninvited bad advice is never in short supply but it has only made matters more challenging for the RBI, the one institution that has been very much with the ball than what it is given credit for. Unfortunately, the RBI has had to pocket too much nonsense""including unsubstantiated claims by some columnists who are better labelled as spin doctors""despite having done a commendable job given the few available degrees of freedom.

A key area of debate has been monetary policy, with the management of interest rates and exchange rate inviting criticism. Since late last year, several analysts have been arguing for the RBI to cut policy rates. But the RBI has (correctly, in my humble opinion) ignored that suggestion. Such an approach was labelled as a "mistake", and we were warned that economic growth would collapse and that the wider interest rate differential with the US would attract a flood of foreign capital that would increase the appreciation pressure on the rupee.

However, the rupee has actually depreciated against the dollar. Further, with the headline WPI inflation edging above the RBI's comfort level of around 5 per cent, the central bank's decision to hold back from easing policy has been validated. This is just another example of the RBI's reading of the broader local and global trends having been far more accurate than those of several analysts, and certainly better than those of the spin doctors doing the rounds.

Several analysts have written about the near-apocalyptic "collapse" in growth owing to tight monetary policy. Some of the same analysts raised similar concerns over the growth outlook when the RBI began tightening in 2004. However, four years later, growth momentum has moderated but remains elevated, and the underlying tone still appears encouraging. Admittedly, some pockets are experiencing a slowdown but that is what a tighter monetary policy was designed to achieve. The fact of the matter is that the RBI has managed to navigate the economy well, despite several domestic and external challenges that it had little control over.

But where do we go from here? I feel the majority of analysts continue to underestimate the underlying economic resilience, ignoring the growth-inflation preference being expressed by the government and the RBI. Note that economic resilience does not mean that there would be no impact on India's growth from slower external demand, and significant moderation in capital inflows from the ongoing global economic and credit woes. But that the effect on India would be much less pronounced than for most other emerging economies.

Most of the analysts calling for an immediate interest rate cut by the RBI base it on expectations of a combination of: (1) economic growth will slowdown significantly; and (2) inflation is either not an issue, or will become less of an issue as growth slows. The advance estimate pegs GDP growth at 8.7 per cent in 2007-08. Most likely, the full-year estimate will be revised up to slightly under 9 per cent. Growth in 2008-09 is likely to be in the 7-8 per cent range. Even an outcome for growth towards the low end of that range is a good outcome considering the scenario of a US recession. The RBI will probably be in a different setting by the middle of the year, and will likely ease policy. The central question on monetary policy is about the timing of easing, not the direction.

Inflation is a trickier issue, and policymakers and the government are rightly more concerned about inflation outlook, especially food inflation, rather than about growth moderation. The sensitivity toward inflation could be more pronounced owing to a slew of state legislative elections and a general election in the pipeline. But even in the absence of a political angle, it is important for India to move towards a sustainable low-inflation trajectory, which over the medium term will facilitate another round of a structural decline in local interest rates (that, in turn, would create another kicker for acceleration in growth, but that is another story).

As is typical with most other central banks, the RBI too has a built-in disadvantage as the broader public general thinks that it always knows what to do, and has all the answers. The reality is rather different: central banks don't always know how the economic landscape will evolve. However, rather than screaming about their ignorance, central banks prefer not to misguide the markets in their communication, unlike many commentators that seem to have solutions even if they don't understand the problems!

Some spin doctors continue to fire away at the RBI by raising questions about its credibility, competency and framework, despite well-documented evidence that the central bank has navigated the economy well with respect to inflation, rupee appreciation and in dealing with unprecedented and overwhelming capital inflows. The spin doctors told us that the elevated levels of capital inflows owed to the rise of Indian economy, and that the RBI was fighting a losing battle, and that the rupee should be freely floating currency. The fact of the matter is that the capital inflows were amplified many times over by the outright increased risk appetite since 2003, the reversal of which we are experiencing now. India's overall balance of payments in 2008-09 is poised to shrink substantially, though the impact of that will be more pronounced on the direction of the rupee against the dollar than on domestic liquidity. The RBI has enough fire power (for example, unwinding MSS and reversing CRR hikes) to inject liquidity without such an injection being inflationary.

The bottom-line is that the RBI has been able to correct the super-bullish but unrealistic and unsustainable expectations that were beginning to feed on themselves. However, it is unlikely to get a pat on the back. More likely, the spin doctors will be working over time to discredit it. They should get a life instead.

The author is Executive Director at JPMorgan Chase Bank, Singapore. The views expressed are personal