For a moment, it looked like Indian monetary policy-making would step out into the modern world. The job of monetary policy is to be forward-looking, to anticipate future possibilities, rather than practise “rear window” economics. And, as financial and product markets around the world globalise and integrate, so should monetary policy divine not only what is happening and will likely happen in India, but also infer the same about the economies of the western world and that of our competitors in Asia. Very likely, this is what D Subbarao had in mind when he joined RBI as governor in September 2008.
That is what all governors have had in mind. But RBI is an old institution, all puns intended. It still believes that monetary policy means controlling the quantity of money, like the good old days of planning. And it still believes, unique among modern central banks, in looking at inflation through the prism of the wholesale price index (WPI). And it still believes that the best inference about the future course of growth and inflation is via use of headline year-on-year (y-o-y) movements in industrial production and wholesale prices.
And these two indicators are screaming — tighten. So are most of the analysts, commentators, and investment banks’ research departments. The “market” demands, nay dictates, a tightening, and reminiscent of Greenspan, RBI readily obliges. The simple point is that a central banks like RBI should act as a leader — ample evidence is that it continues to act as a dutiful market follower. What the above evidence indicates is that Dr Subbarao has given in to the slavish market followers — always late to do the right thing, and consequently, almost never right on time. (Click hre for table)
The table illustrates the folly of RBI, and now Dr Subbarao. The first two rows in the table illustrate how we do policy. In the US, no one has been caught napping, or defining inflation via the US equivalent of the WPI, the producer price index (PPI). The deficiencies of this index for inferences about generalised inflation are well-known outside of India; nevertheless, even this deficient index can yield inferences if used with delicate care.
What the US PPI (not seasonally adjusted) shows is that inflation has been high in the US, and extremely volatile. It was in double digits in the first nine months of 2008, then collapsed into deep negative territory post-Lehman for the next 12 months, and then bounced back to nearly a 9 per cent level in March 2010. In June 2010, the y-o-y PPI for the US was rising at a 5.4 per cent rate. What is the actual inflation in the US? Going by the GDP deflator (or the CPI), inflation has been running at close to a 1 per cent rate.
Now a similar calculation for India. Almost identical pattern to the US, for both the WPI and the GDP deflator! There is a difference in the level of inflation — in the US it is close to 1 per cent, in India it is close to 4.5 per cent.
Three-month seasonally adjusted annualised rates (3SAAR) data for the US and India show a similar pattern. What is noteworthy is that, as of June 2010, 3SAAR WPI inflation in India is running at a 3.3 per cent rate. And yet an anonymous but true-blooded senior RBI official is clamouring for raising rates even more because his analysis (sic?) suggests that we have runaway inflation in India. S/he can peruse these data at leisure, but the story of misconception and misguidedness at the highest policy levels in India will not change.
The effects of this misguided policy are clearly seen in the data on industrial production. The bounceback from the post-Lehman decline (quite noticeable in the US as well!) was interpreted by our monetary masters as over-heating. So, the great unwinding started — we have to get back to normal and raise real rates up and back to the “normal” 2008 levels. While the rest of the world is talking of a new normal of lower growth and even lower inflation, our conventional-wisdom (CW — an abbreviation shared by the clueless in wonderland types) analysts want to get back to nominal interest rates of 2008! A year (in)famous for the highest oil price of $147, the highest euro price $1.60, the highest food prices, and the highest practically any price you can think of. And that is the pre-Lehman “normal” our experts are advocating!
It is advisable to look carefully at the three-month SAAR data. Our policy-makers’ expectation of 8-9 per cent GDP growth was predicated on industrial production growth at near double-digit levels. As we bask in the glory of y-o-y double-digit industrial growth, note that for the last six months, January-June 2010 (June y-o-y industrial growth estimated by Oxus to be close to 8.5 per cent), such growth has only been around a 1.5 per cent annualised rate. Recall a near-identical train wreck in pre-Lehman 2008 India. We used the same misguided y-o-y WPI (and food!) inflation numbers to tighten furiously in 2007-08, and brought industrial growth down to zero per cent in August 2008 — that is before the Lehman September. Unfortunately, with RBI, history repeats itself as both farce and tragedy much too often.
What we have had in India is food inflation, an inflation which is not attributable to monetary policy but entirely to gross mismanagement at the Centre. The correction of that does not entail a tightening of monetary policy. What RBI possibly doesn’t realise is that it is falling into the well-laid trap by the central government. As food inflation falls because of good weather and/or less bad-bad food policy, the Centre will claim credit. And as growth falters because of bad-bad monetary policy, the Centre can point fingers at RBI — don’t ask us, look at the misguided RBI.
The author is chairman of Oxus Investments, an emerging market advisory and fund management firm. Please visit www.oxusinvestments.com for an archive of articles etc.; comments welcome at: surjit.bhalla@oxusinvestments.com
