Our objective is price
stability with full-employment. Because when there is full employment there is
no one dependent on the State, means a zero fiscal deficit, which actually will
necessitate no further taxes. The economy will be in equilibrium... But our
main problem is “non-accelerating-inflation-rate of unemployment”, NAIRU. It is
different for different countries. It is calculated by research. But we think
in a large country like INDIA it must be around 4-6%. But our current unemployment
rate is 3% which is out of our range (4-6%) in which inflation becomes low and
stable. It is in a range which has put pressure on prices to go up, an upward
bias... Income is rising faster than employment. The market is competing for
labor and the RBI has put brakes on the interest rate which has also put brakes
on higher wages and income (indirectly). The RBI is trying to avoid a
wage-price spiral but in the long-run wages and income will go up in real terms
because we are trying to converge our per capita income to the developed
countries' figures. Wages and income rise in real terms also when prices fall.
As long as the RBI can not tolerate higher wages and income it can concentrate
to look at the real side of the issue, lower prices and higher real wages and
incomes. But inflation (WPI) is again inching above to hurt real wages/income.
We think in the short run the RBI can choose to keep the value of money, and
therefore, wages/income intact by choosing higher interest rates (months)...
Indian economy is not
demand constrained, it is supply constrained. There is absolutely no doubt
about the growth potential... the doubt is about when... when we would be able
to reduce the interest rates... And, that will happen when inflation comes down
to our target (5%)... The government should aim at removing supply side bottle
necks and the RBI should take care of the finances by reducing interest
rates... The stock market in INDIA is very responsive, it is responding on all
the relevant information. It is active... We in INDIA have subdued the demand
pressure by not reducing interest rates... Industry is waiting for rate-cuts so
that they can resume (investment) spending... But after the last two rate hikes
the Industry is worried about another such action from the RBI considering high
inflation (food and fuel)… It is also expected because lower prices is a relief
for all, especially food and fuel
prices, and when we lower prices by increasing interest rates it is also
good for investment… our savings and yield on savings increase… we become
richer… Therefore, it is in the interest of the economy to lower prices by
increasing interest rates… An inflation
rate of (above) 10% is enough for invoking monetary policy action… We in INDIA
are over-employed we are working longer hours and are paid less than our
developed country counterparts. “INDIA IS OVER-EMPLOYED” not only unemployed.
Unemployment is not a major problem in INDIA, therefore, we need to look at
inflation, and, real wages and income…
We, in INDIA are
advised to impart skills and traning to our work-force which is expected to
increase productivity and wages. Higher productivity means higher wages which
also indirectly means we are, now so far, under-paid and we are doing jobs
longer. Use of skills make any task easier and it takes less time therefore we
need to match skills with jobs. Without which any task would be a little
difficult or harder. We have to work a little harder and longer. We are paid
according to the marginal product which would be less if we are employed
elsewhere, wrong skills and job match. In this sense we are over-employed
because we are getting less and working same hours as the right jobs and skill
match. We are over-employed because we are being paid less. Nevertheless the problem
of over-employment co-exist with unemployment in INDIA because we are growing
slower and are adding less jobs every quarter because of, again, high inflation
and interest rates which has put a hold on investment. Our real wages are low
also because of high inflation. We need to improve real wages if we want to
correct the “tag” over-employment because it restricts the economy’s demand and
consumption which is directly responsible for the level of employment and
growth. Our RBI Governor is giving more importance to inflation over
unemployment which also depends on the same (inflation). If inflation goes down
interest rates will go down, and, real-wages, investment, employment and growth
will pick-up. A low level of inflation is also necessary for a high level of
employment or low level of unemployment…
Before the RBI the question is not just
inflation… it is actually a trade-off between inflation and unemployment. If
inflation is high the central bank chooses a lower level of employment by
raising interest rate. On the other hand, if unemployment is high it chooses a
higher level of inflation by lowering interest rate. To sum up, a central
banks’ job is not just keeping check on inflation but to ensure full
employment, as well. Just to note, full employment is established before 100%
employment, at 95% employment or 5% frictional unemployment.
Unemployment…
We generally talk about
real interest rates and indirectly about the cost of capital. But totally
ignore the labor and its cost (wages), the real impediment to growth. The level
of unemployment is a real constraint, about which we are lacking updated data (INDIA).
Investment increase up to the point of full employment and after that wages
keep on increasing because the market then competes for labor because, again,
after that labor becomes scarce. After, again, full employment only wages and
income increase... Both real and nominal interest rates decrease before
full-employment and after that the gap between real and nominal interest rate
starts increasing because production can not be increased because of
full-employment (labor is fully employed) and to control inflation we need to
increase interest rates ... Both labor and capital are means of production but
labor is more scarce than capital. Actually capital is not scarce, at all (read
Keynes General Theory). The credit growth in INDIA is 16% and the deposit
growth rate is around 12% which means demand for funds is higher than the
supply, and, when demand is higher we need to increase supply by offering high
interest rate to depositors; Inflation is eating into the savings, people are
saving less, now. We need to offer higher interest on savings so that people
consume less and save more to maintain the supply and demand balance…
We read at many places that in 2012
unemployment rate fell to 3.8%. We should be surprised that how with a high
interest rate, around 8%, and with everybody keeping their hands-off of
investment unemployment rate fell to 3.8%? If it has and is true… it is a sign
of overheating of the economy and, now, we do not wonder, anymore, why
inflation is so persistent.
India's real GDP at 5%
is good, not very low, when rich countries are doing at 2%. China is growing a
little better at 7%, exports are an advantage. Their nominal GDP must be much
higher... To be more exact, INDIA’s nominal GDP growth rate is equal to real
GDP plus inflation means, 5% + 10% (inflation, CPI) = 15% which is not
sustainable because inflation is too high, income, consumption, and
saving/investment is lagging behind. It is so high that no bank is giving 15%
interest on savings a year. Banks are increasing income 9% a year. However,
public and private spending is rising under compulsion under price-rise… In the
long run when inflation is assumed zero, real GDP growth rate will equal
nominal GDP growth rate in equilibrium. The long run potential GDP growth rate of
the Indian-Economy is 12% because its population growth rate is 17% (every ten
year), and, deducting frictional unemployment of 5% it comes to 12%, the rate
of growth of labor force and employment to maintain full employment. Therefore
India's full-employment long-run potential growth rate is 12%. And, under
equilibrium, full-employment long run potential GDP growth rate (12%) = nominal
GDP growth rate (12%) = real GDP growth rate (12%). But, the situation is 12% =
15% = 5%.
The last one, the real
GDP growth rate is a long run goal. In the short run we have achieved the
target with nominal GDP growth rate at 15%. Indian economy is at full
employment with all the supply side constraints. In 2012 the unemployment rate
for Indian-Economy fell to 3.8% which is why inflation is so high and
persistent. We can not achieve 12% real GDP because we can not tolerate
inflation above 10%. The benchmark we have set for our selves. We need
patience. No doubt inflation is the major problem…
Fiscal-deficit and
Subsidies…
For the past 2-3 years
we are in the realm of high fiscal deficit and high inflation. However, it (the
fiscal-deficit) fell to 5.2% from that initial target of 5.3% in the budget
2012 and in 2014 it is expected to fall to 4.8% of GDP. A simple rule of economics
is that whenever money supply increases, either by government or by the central
bank, it stokes inflation… Moreover, we are continuously discussing that fiscal
deficit as high and the government, too, is planning to bring it to a
sustainable level. Both the govrenment and RBI can affect demand... The
government through loose fiscal policy in programmes like MNREGA… it is pumping
wages and income... Rural areas got a boost in the same terms (wages and
income) and demand is built…
Fiscal deficits are inflationary
because government spending is increased but subsidies on essential products
like fuel are there to contain price rise and inflationary effects since
transport cost is a major determinant of prices of goods in an economy. A paper
by Paul Krugman “Increasing Returns and Economic Geography” for which he has
been awarded Nobel-Prize, too, says that transport costs play a major role in
the overall price structure of an economy. Therefore, from the point of view of
inflation subsides are good because they keep expenditure on transport divided
between government and the economy (consumers and producers). If the government
had not shared the prices of fuels then the whole price for fuel must be paid
by the economy, consumers and producers, both. To sum-up, Fuel-subsidies are
anti- inflationary, but, they increase government expenditure and sometimes
revenues are short but the impact of rise in fuel prices is felt by all. The
government either has to prop-up production of fuel, which in the short-run not
possible or it can help reducing the pressure on prices paid by the economy.
Subsidized fertilizer
means subsidized food grains. The question arises “why the government supported
the food grain prices till now and why, now, it wants to discontinue this practice?”
There can be two possible answers, one, the government wanted to rein in
inflation and inflationary expectations, and, the second one is, that, it
wanted to support the farmers, anyways. If the government wanted to lower
inflation then why, now, it wants to leave the economy in doldrums when
inflation is already high and is not coming down. This is not the right time to
discontinue subsidies. And, if it (the government) wanted to support the
farmers, then, why, now, it feels it appropriate to leave them to the market,
the argument given in favor of FDI in multi brand retail, when it has not
arrived yet. Subsidies distort the price structure the market offers. Till now
the government provided subsidies and bought the most of food grains itself. It
never intended the market to support the farmers which could offer them higher
prices and also the capacity to pay for fertilizer, themselves. It has
literally exploited the farmers so far and now it will push the whole economy
back to high inflation. The proposition that government now wants to
discontinue subsidies due to high fiscal deficit is acceptable, but, is the
food grain market in INDIA, now, sufficient to factor in the cost of fertilizer
and pay for it without increasing the prices of food grain and overall
inflation? It is not possible. Let us wait for the FDI in multi-brand-retail,
if it happens, amid all the discussion…
In the recent years the
government has decided to curb fiscal-deficit to bring inflation down which
rattled high due to fiscal profligacy during recession, 2008 onwards. The
Economy’s demand needed to be restricted because people are getting more and
are spending more. Investment needs to be recycled to the good and services
market through savings. But since now we are spending more we have less to
save. Interest rates by banks are not enough to attract depositor and moreover
it is unable to spark investors due to higher interest rates. The demand is
coming from the bottom of the pyramid due to employment creation in the economy.
The chain breaks where high interest rates keep a tab on investment. The main
problem is employment creation and little inflation motivates the market.
Public employment creation is crowding-out private investment and employment
creation. We have to decide which one, private or public, employment creates
reasonable inflation levels.
Monetary-Policy…
The RBI's credibility
depends upon his actions. Price stability and full employment are two
macro-economic objectives of monetary and fiscal policies. The economy on the
employment front is doing fine but we need price stability to check
inflationary expectations to limit the demand for increase in income and wages
economy-wide to avoid the cost-push -inflation.
If China can grow 8%
amid all the crises in the trading regions like the US and Europe India too can
achieve 7-7.5% if it goes for domestic demand. China’s dependency on exports
for growth is well known and is also advised to concentrate on domestic demand.
In India the Reserve Bank of India has subdued the demand for investment by not
lowering the key interest rates. And the day repo-rates will go down
investment, economic activity and growth rates will pick-up. We can easily
expect the growth rate for Indian- Economy at 7.5-8% if inflation and repo-rates
come down. We can easily remember how fast the growth picked up back in 2008
when the economy received high doses of fiscal and monetary stimuli due to
sub-prime crisis in the US. We do not think we need to worry too much about
growth.
Many disagree that the
main gauge of inflation is WPI, and, it is neither CPI nor core-inflation
(manufactured products). If we (the authors) had to choose an indicator of
inflation we would go for food-and-fuel-inflation because the argument is that
we need to protect the value of money poor people are getting because their
income/wages are more or less indefinite, and, depends upon a variety of
factors like season and availability of work. Poor people do not consume all
the products WPI, CPI and core-inflation take into account, ninety percent of
their consumption basket includes food-and-fuel.
We, especially the
RBI,consider WPI as a gauge of inflation but other countries like the US and
the European countries use CPI as better indicator of inflation which if we
consider is above 10%, in INDIA. An inflation rate of 10% is enough for a
policy response. But since INDIA is supply constrained we have accepted it as
normal. As far as growth rate is concerned which dipped to 5% in the last
fiscal the RBI needs to reduce repo-rate by at least 150 basis points to push
back the economy to 8%, according to the Taylor-Rule. Of the 150 basis point
the RBI has reduced repo-rate by 100 basis points so far which can catapult the
economy to around 7% growth rate. But to achieve 8% growth rate the RBI needs
to reduce repo-rate by another 50 basis points and to achieve 9% it has to
reduce repo-rate by another 50 basis points. But this can not be done due to,
again, supply side constraints. Just to note, the RBI reduced the repo-rate by
300 basis points from around 8% to 5% to avert recession in 2008 which pushed
the inflation rate from 10% to 20% and growth rate from 6% to 10%. For INDIA
growth is not a problem but the supply side bottlenecks are. We disagree that
growth in INDIA will not evoke inflation because so far it has...
To be precise, the RBI,
for every extra percentage of inflation, should increase interest rate by more
than one percent. Therefore, if the RBI inflation-target is 5% and we have
inflation rate of 10% we, at least, need to increase interest rate by 500 basis
points. This is not unimaginable… Way back during 1970s, in the US, the Fed’s
head Paul Volcker raised interest rate from 11% to 21%... But the unemployment
rate rose to 10%. We are not sure way back, then, in the US had the kind of
unemployment-benefits it has, now. These benefits show our tolerance towards
unemployment… Unluckily INDIA has no such mechanism that decides our tolerance
towards unemployment and, but, luckily unemployment is not a big problem. It is
near 6% (as per our FM), manageable. Therefore unlike the US, in the absence of
any unemployment benefits, INDIA can tolerate less unemployment to let the
prices cool down. I’m not expecting a knee-jerk reaction but during a slowdown
when the source of income dries-up a lower inflation is like an ointment… we
can easily expect the RBI to raise interest rates some more. Capitalists will
be benefited by the action and the lay man’s relief due to lower prices.
Moreover there has been
a gap between our savings growth rate and the lending growth rate, and, people
are more eager to invest in physical assets like land and gold. This can be
attributed to the negative real interest rates (nominal interest rates minus
inflation) on savings. To close the gap between savings growth rate and lending
growth rate we need to make saving a little more attractive so that it could
catch-up the lending growth rate and exert less-pressure on interest rate to
increase…
Food-Security-Bill and
Cash-Transfer-Scheme (CTS)…
Growth is contingent on
the Food Security Bill because food and fuel inflation is still around 10% and
is hovering around that level since 2004. Very sticky. Fuel prices depend on
international factors such as dollar prices and external demand over which we
have little control. But food prices are largely determined by internal demand,
which is high due to fiscal expenditure, and due to internal supply conditions.
I agree weather conditions were not conducive last year (2012) but the
government has enough food grains in its coffers. And, definitely it can
contribute in reducing inflation and inflationary expectations. The government
is treading so slow...
We in no way are
opposing cash-transfer-scheme (CTS) but the ground realities tell a different
story; a cash strapped government and a lonely central bank fighting with
inflation… It is like telling people about something we can not deliver, right
now, but the government looks in haste. Cash transfer schemes have been
successful in other countries (like Brazil) to make a dent on poverty which
India can replicate, but, with a pause, till the supply side is good enough to
take the shock demand presents. We are sure such a scheme would necessitate a
little inflation and we have to choose we want it right now or with a time-lag.
If we go for former we will have to chose an inflation target of 10% or more,
but, if we go for latter we will have to wait for some time to let the
inflation cool-down and chose an inflation of 6-7%.
No political party can
dare to oppose a scheme which covers a large population but they should endorse
their own versions/variants of the Food-Security-Bill and the CTS...
Current-Account-Deficit
(CAD)…
Every country needs
foreign currency to pay for its imports, and, reduce the gap between exports
and imports, called the CAD (Current-Account-Deficit). The CAD in INDIA has touched an all time high
of 4.8% of GDP in 2013 on the back of high gold imports but our policy-makers
were committed to bring it down and by using import-tariff on gold which
reduced our imports of gold and we are now expecting the CAD to come down below
3% of GDP in 2013. Now, sustainable…
Fiscal deficit also
fuels inflation and depreciation, which makes exports competitive. Inflation
means more money in circulation which depreciates the home-currency; it gives
exports a competitive advantage in terms of the value of home-currency. We can
see this example in India itself; inflation is high and currency depreciating.
Depreciations give country a competitive advantage. If we can not exploit the
situation due to higher interest rate, is a not a thing to be amazed…
No doubt Indian
currency is very weak but that is a good thing and a good thing even when
compared to the gains from a strong currency. With a strong currency we buy
products of a foreign country and employment is created in foreign. But cheap
currency gives exports an impetus which creates employment at home and
increases tax base. Currency depreciation is always good. Even if Indian
currency depreciates further it will help the economy in the long-run. The larger
the gap between the strongest currency and weakest currency the more it will
take to converge to its true- value, equilibrium exchange rate. And, the longer
will be the advantage of the country “of being cheap” for currency or for
products. Currency depreciations have pulled out economies out of recessions.
And, developed countries welcome it...
A depreciating currency
result in outflow of foreign exchange as happened in INDIA during recent past.
Nevertheless, the news about the possible taper of the Quantitative-Easing
programme in US also affected the inflows. An outflow of foreign exchange would
mean a depreciating currency because the supply of foreign exchange to the
economy has decreased because, again, demand for the economy as an investment destination
decreases. Low supply means stronger foreign-currency and weaker
domestic-currency. Our ability to pay
for imports will decrease, because we can buy less foreign currency since it is
strong now. This will result in higher CAD and, therefore, this time we need to
push exports so that we can earn more foreign exchange to reduce the CAD gap.
But, if there is an inflow it means that the supply of foreign currency to the
economy has gone up and the home currency will appreciate now because foreign currency
will depreciate since its supply has increased. We know, again, high supply
means a weak currency. This will lower the CAD. Our ability to pay for foreign
currency and imports will increase. Countries really do not bother to reduce
surplus, rather they are more bothered to reduce the deficit. The confidence in
an economy is an important determinant of foreign currency inflows and
outflows. A healthy economy will attract more foreign currency and a weak one
will repel others. Growth rates are an important indicator of economy’s health
and confidence. A high growth rate with a high interest rate will attract more
foreign capital and vice-versa. High foreign currency inflows reduce the CAD
burden and low inflows aggravate it, if exports are not responding. India’s CAD
problem was due to high imports and low exports; we have a shortage of foreign
currency reserves. A real and natural solution to reduce the CAD is to give a
push to exports, but, due to high interest rates nobody took initiative in that
direction. Manufacturing in the export sector was very low and India defended
its position by exporting non-manufactured products like food-grains, mainly.
But, that is not enough to reduce the CAD. Moreover, FIIs and FDIs are not
helping us out of this serious CAD problem, because they had become low in the
recent years because of low growth rate, but, now improving. India needs an
out-of-the-box solution to handle the CAD. We, basically, need to earn foreign
exchange in order to bridge the gap between the imports and exports.
The Indian currency
depreciated from Rs 45 per-dollar in 2011 to Rs 68-70 in 2013 after which it
regained some of it lost value and is, now, trading near Rs 61-63 per-dollar.
It is in the interest of the RBI to keep the rupee value strong because then it
will have to pay less every dollar, for imports too, and build a strong balance
sheet by accumulating more dollars... If the RBI sells dollars and make the
exchange rate more affordable it can buy more dollars per rupee. And, by doing
so it can keep the demand and supply of US $and the Indian-Rupee match each
other. Now that we have accepted that, again, the Indian rupee is overvalued
(at Rs 62.5) and we need to bring it closer to its real value or inflation
adjusted value near to Rs 58-60 according to the REER (real-affective-exchange
rate) index., Some advise the RBI to recoup dollars when the dollar is high.
But, why the RBI did not do the same when the rupee was trading 45. The answer
probably lies in the fact that the RBI was busy in accumulating gold. The RBI,
too, with the investors accumulated a lot of gold last year... which is not a
bad investment… gold and dollars are almost substitutes to each other… both
enjoy the status of safe-heaven… Therefore
we should see gold as a part of foreign currency reserves and should not press
the panic button, and, wait for the right time when it is down and does not
increase demand and price of dollar or if it is brought down by supplying more
dollars. The question is how much the rupee has a value in the RBI’s mind
because it has the autonomy to print currency…
Nevertheless, the
depreciation in the Indian unit and interest rate sops by the government made
exports more competitive which grew 13% post-depreciation in 2013…
We can earn foreign
exchange without resorting to exports and FIIs…Yes, we can earn foreign
exchange without pushing for exports and FIIs, but, we will need FDI and, most
importantly, in multi-brand retail. We have not opted for imports of goods and
the investors in this space will have to source goods and services locally,
from India. This is a clause. And, to this we need to add one more clause that
when we will supply we will only accept dollars or euros. In the short run we
may not be getting too much foreign currency because foreign firms are pouring
foreign currency, anyways, to the banks and money market. Yes, banks and money
market, but, not in the real market… In the goods and services market… And in the long run it will definitely help
us. I do not think foreign firms will have any problem with this because they
can easily borrow money in their respective countries. So where is the big
difference? Moreover this would help them because this will make the Indian
currency strong in the long-run and they will earn more home currency for
themselves.
This will help India in
many ways;
(i) Build reserves: It
will help us build reserves because that will eventually go through the banking
system and in terms of bank deposits, too.
(ii) Strong domestic
currency: Supply of the dollars to the economy will improve and the domestic
currency will appreciate, other things remaining constant, and,
(iii) Automatic
investment: There is a chance that dollar will appreciate because to buy oil we
will need dollars. There is a decreasing returns coming out of oil. Demand for
dollars is likely to go up with oil-demand and prices, and, with it income and investment
in dollars.
Moreover, after gold
import compression we have more room to reduce the CAD by compressing steel and
coal imports of which INDIA has considerable reserves…
Lack of Skills and
Red-Tape, and Technology…
Demographic dividend
makes the Indian story fundamentally strong. Foreign-exchange inflows are
influenced by this strong potential growth rate. They are celebrating it. But
with an uneducated and unskilled population we are not going reap a huge
dividend without increase in productivity and wages/per-capita. The long term
goal is to achieve a higher per-capita income and consumption; everybody is
heading in that direction. To cut short, a decent lifestyle... Many argue that
we need to make people learn “how to fish” instead of giving them fish.
Education and skill development is so crucial for an emerging economy that its
long term goals can not be achieved without these two. They make people
independent who are dependent on the State for their livelihood. The
unemployment figures, 2.2, for the year 2011-12 says that employment is not a
problem in INDIA but lack of skills are, which increases productivity and
wages/income. INDIA is stuck with subsistence wages without proper skills for
its masses that can raise their incomes and reduces their exploitation. It is
hard to deceive an educated population on matters of what the State has to
offer for a “good-life”. The State should focus on making them independent and
not dependent…
INDIA has a comparative
advantage as far as labor and wages are concerned even when compared with China
but high interest rates, lack of skills and technology are blocking rise in
exports. Why can not we take advantage of this is largely unexplained? Probably
the answer lies in lack of entrepreneurship culture. People are very hesitant
to take initiative because of the Red-tape in the process of
manufacturing/production. We need to ease rule and regulations to start any
process of production. This also may be due to shortage of skill-sets and
know-how. People do not know, with skills shortages, that what they can do and
what are the opportunities. Both skills and manufacturing are complementary
ideas. One can not survive without the other. Skills should be such so that
they can be consumed by the market. We need a survey that what skills should we
impart so that every Indian is absorbed in the process of growth and
development. We should also allow our foreign counterparts to help us in this
direction. FDI in education and skills is feasible so that new technologies and
skills can come to the Indian market...
If the government has surplus and wants to
invest it somewhere meaning fully it should invest in human capital, on
education and skill development. The merit of this kind of investment will be
to create more employment opportunities through multiplier. Employment
multiplier is older than investment multiplier and is also the root of the
same. Keynes used employment multiplier to create investment multiplier. It
simply says that if we create employment/investment by public spending it
actually creates employment/investment at other places, a multiple of the
original employment creation.
The government allotted
Rs 1, 000 crore for 10 lakhs youth for skill development in the 2013 budget. I
surprise whether we actually have this number of people who need skills
up-gradation. India where half of the population is illiterate and poor who can
not take care of themselves we, atleast, need to upgrade skills of minimum 1
crore people for which we will need atleast, again, Rs 1, 00, 000 crore. Skill gap in India has
been widely discussed and is recommended by reports and surveys. We needed a
big investment so that we can increase the productivity of our labour-force and
they can earn higher per capita income. This was a good decision but
insufficient to achieve the objective in mind.
The priority for the
country in the long run is to increase employment opportunities and a higher
per capita income for the growing population and, in short, more tax because of
our ever growing demand and magnitude of poverty. No major country is without
poverty. Poverty in emerging economies is a major issue and more acute in terms
of numbers. Therefore to remove poverty we need more jobs for those do not have
a job. Manufacturing may be capital or labor intensive depending on the level
of technology but for a labor rich country a labor intensive technology is more
appropriate to reduce unemployment. Therefore as far as technology is concerned
we need to use more labor intensive technology in manufacturing and they would
be cheap compared to capital intensive techniques.
Stagflation…
Indian economy is
stagflating… What is stagflation? Low growth-rate and high inflation. India’s
growth performance has been low than its previous performances, before 2012.
India was growing 9% but now the growth rate is 5%, since past few years.
India’s growth performance is good when we compare India with the West but low
when compared to China and INDIA’s previous performances... it is a low growth
rate given India’s population and poverty. Moreover, as far as inflation is
concerned it is also pointing in the same direction, stagflation. Inflation in
INDIA is 7% (WPI) and CPI above 10%. When we compare India’s inflation with
other countries we find that others have chosen 2% inflation for themselves, in
the west, and, complete price stability in China. Inflation in China is 3%. No
matter what target we set for ourselves but theoretically we need complete
price stability if we are not trying to break recession. INDIA’s inflation
(CPI) is high. Therefore, on both fronts, growth rate and inflation, the
present situation suggests a stagflation type scenario...
Policy Paralysis…
The pressure on prices
is and was not only because of demand but also because of supply-side, and to a
greater extent. The decision taken by RBI not to reduce aggressively has once
again put the ball back to the government’s court to hasten the reforms process
and put it back on the burner. The government has proved itself, once more, a
major road-block in the direction of growth and development, poverty-
alleviation, mainly. The government has failed at two occasions. Firstly, it
could not ensure an efficient supply mechanism for food, it lost the crucial
time to act, and it is only preparing ground so far. All the decisions are
stuck for years even in case of food grains which are more than full in
government storage and sometimes are rotten there. And, secondly on FDI in
multi-brand retail, an area in which the government failed to tell and convince
people that how it can help the Indian-Economy. In our view it will help
agriculture to become more profitable and would boost investment there. Our
total economy would be benefited by higher incomes because demand would spurt.
These both are not independent of each other and point towards the same goal of
price stability which the FM committed while fiscal consolidation. The
government needs to be more serious and quick if it has to address the issue of
growth. So far, it has only created propaganda...
While Concluding…
The only thing that is
holding Indian growth story back is high inflation and even restricting the use
of fiscal policy to boost growth… Inflation in India is a structural problem.
Markets are not that efficient. They take too much time to respond to increases
in demand pressure. They do not operate with sufficient reserve or spare
capacity. Any little increase in demand is likely to upset the supply
conditions. Prices are very sensitive under these supply conditions. I hope FDI
in multi brand retail would help removing supply side bottlenecks and consumers
(we all consume but we all do not produce or supply) would be benefited in form
of lower prices. As far as the question of expected growth rate of the
Indian-Economy is concerned we are sure economists would not have expected a
growth rate lower than 7-8% if RBI had lowered the key interest rates-repo and
reverse repo rates- by 50-100 basis points. One more thing that any central
bank takes into account is unemployment rate. If unemployment increases, growth
rate decreases and vice-versa. Only if the unemployment rate in India above the
RBIs target, above “natural rate” or NAIRU, it has some room to lower key
interest rates by choosing a higher inflation target around 10%. If it does so
we can easily see the growth rate of Indian economy around 7-8% in the next 4-6
months. If, again, infrastructure and supply side bottlenecks were not there
the chances are that the economy would grow with a growth rate more than the
rate of inflation (WPI), means 7-8%, because inflation is also an index of
increase in consumer spending even if it is under compulsion, read price-rise.
The higher (rational) the inflation target set by an economy or the actual
inflation the higher the growth rate probably it can achieve. As soon as the
food-inflation comes down with the implementation of the Food-Security-Bill we
will have more room for aggressive monetary easing. We are worried about
foreign inflows even when our interest rates are high due to elevated inflation...
There are three major sources of liquidity, liquidity from monetary policy,
liquidity from fiscal policy and liquidity from foreign sources. We although
pursued a tight monetary policy but we never disallowed investment from the
other two sources… We were worried about drying-up of foreign sources because
we can not reduce interest rates at home because of high inflation.
Nevertheless the CAD was a concern… we needed to improve our foreign exchange
reserves for a good rating…Therefore, liquidity can come from any or all of the
three major sources. Therefore, again, we need not to worry about foreign
currency outflows because when capital will leave your shores that would also
bring inflation down and we have more room for loose monetary policy at home.
Quantitative-Easing (QE) in the US is an unconventional monetary policy which
is poised to go down one day; if QE dries-up we can easily cut-back on interest
rates and improve liquidity to the economy but only when the Food-Security-Bill
is implemented and inflation comes down close to our target. Demand for cereals
has a considerable weight in the CPI and the government has enough stock of
food. If inflation and supply side factor are considered it is a structural
problem because of high inflation, especially oil (we can do little about) and
food, which are stuffed in government coffers. It is all the indifference of
the government which has made prices overshoot the inflation target, and this
is about food and food prices... Therefore, if prices are high due to
mismanagement of the government and fiscal spending (too much), it is a
structural problem. Liquidity I do not think is a problem since inflation is
high and prices are a problem, “too much money chasing the government food
stock”... It is important to bring Food Security bill than to attract FDI in
multi brand retail. Both are aimed at controlling inflation by removing supply
side bottlenecks for food... The demerit of FDI in multi brand retail is that
it makes us dependent on foreign capital inflows. We agree that FDI's are
long-term investments but food-security is in our own hands and we are delaying
its transmission to higher growth rate because high food prices are stopping us
in from lowering interest rates… Fiscal
policy has pumped so much liquidity in the system that the economy has reached
its limits pushing the prices above the roof in the face of higher
wages/income. Both monetary and fiscal policies can give demand a boost...
Therefore liquidity is coming out of the fiscal policy. The RBI while
manipulating interest rates should also take into account the Fiscal-Deficit.
Everybody is admitting that it (the deficit) is high including rating agencies…
The rate of inflation may be gauge of liquidity in any system, we even make use
of the notion that “more money supply, more inflation”. Therefore, money supply
can also be increased/decreased through fiscal policy... We’ve heard many
people saying that there is a problem of liquidity but when we see the rate of
inflation (above 10%) we have a “real-gauge of liquidity” too. We believe our
(new) RBI Governor (Raghuram Rajan) will take fiscal deficit (too) into account
before deciding for interest rates. We think we have case for increasing
interest rates… RBI has not one but two big reasons to hike interest rates.
Number one inflation which is above 10% but we do not consider CPI as an index
for inflation. We have accepted WPI as a gauge of inflation, more appropriate
for rate cuts. According to CPI both food and fuel inflation are above 10%... Therefore
to restrict demand and bring it down near to 5% we need to raise interest
rates. The second reason is falling growth-rate of bank deposits. Our deposit
growth rate is lower than our lending growth rate which is the second reason to
increase interest rates. People are discouraged because the interest rate they
are getting for their savings is less than rate of inflation. Means real
interest rates (nominal interest rate minus inflation) have become negative.
Higher interest will also attract foreign currency inflows…
