Why RBI is a failed doctor

Dr Bharat Jhunjhunwala
One sick person used to go to the blood bank to sell his blood every week. He became very weak. The doctor would give him vitamins or glucose but his health would not improve. That is the situation facing the Reserve Bank today. It has raised the interest rates a tad in the recent Monetary Policy. The small increase indicates a helplessness of the Bank. More increase would have brought inflation under control but hit at growth rates. On the other hand, reduction of interest rates would have pushed growth but led to higher inflation.
Prices rise because the Reserve Bank of India prints; and the Government borrows that money for meeting its expenditures. Say there is 10 kg wheat available in the economy and notes worth Rs 100 are in circulation. The price of wheat is Rs 10 per kg. Now the RBI prints Rs 20 and the Government borrows these monies and buys out two kg wheat from the market and removes it from the economy. There is only eight kg wheat remaining in the market while notes worth Rs 100 are still in circulation as previously. The shopkeepers smell shortage. They increase the price of wheat to Rs 12 per kg. This is how prices are rising presently.
The RBI is printing and the Government is borrowing huge sums of money for meeting its expenditures such as increased salaries of Government servants and for supporting leakages of the revenues to preferred individuals. Much of this money is sent out of the country. But RBI’s printing presses continue to churn out notes and there is an increase in money supply while the goods available are as previously. The Reserve Bank’s hands are tied in this situation. The Bank can increase the interest rates and reduce the money in circulation. People will borrow less at high rates of interest and money in circulation will reduce. But this will simultaneously increase the price of loans taken by industries for meeting their needs of working capital. The production will reduce and that will lead a reduction in growth rate along with an increase in prices.
Second problem is the decline in the rate of economic growth. We had reached the level of eight percent but are now struggling to even hold on to five percent today. Reason is decline in investment by the Government. Say there is an autorickshaw driver who earns Rs 1,000 per day. He saves Rs 300 and manages his household expenditures with Rs 700. He saves money and buys a taxi. Now he earns Rs 2,000 and saves Rs 600 and consumes Rs 1,400 per day. His consumption has increased from Rs 700 to Rs 1400 per day because initially he reduced his consumption. This is the natural process of growth-cut current consumption, increase investment and beget increased consumption in the next cycle.
But instead of cutting consumption and increasing investment, our Government is borrowing to increase consumption like paying increased salaries to Government servants, and spending on welfare programs like MNREGA, Right to Food and mid-day meals. This is leading the economy getting mired in debt. This lack of investment is the primary cause of decline in growth rates. The same borrowing would have a positive impact if the Government used the money for making investments in ports, highways and research.
The only thing RBI can do in this situation is to increase the interest rates so that it will become difficult for the Government to borrow-and-consume. But it is doubtful whether even such a measure will deter the Government from pursuing this disastrous policy because its eyes are fixed on the coming General Elections in 2014. The Government’s effort is to use money to buy votes and also somehow manage to hold the economy together till the elections are over. The increase in interest burden will take place in the future years only. If RBI adopts the policy of increasing the interest rates it will adversely impact the industries. The production will be reduced and that will lead to an increase in prices. So the RBI is essentially helpless in this situation.
Third problem is of Current Account Deficit (CAD). This is the difference between our export earnings and import requirements. Our exports are less and imports are more. There are two ways of meeting this deficit. One way is to allow the rupee to depreciate. A cheaper rupee will make imports costlier. A Washington apple costing $1 will be sold in India at Rs 70 instead of Rs 50. On the other side it will make our exports more competitive. Our imports will decline, exports will rise and the Deficit will be gone. This is the policy that Man Mohan Singh had adopted as Finance Minister in 1991.
This time around he has adopted an altogether different and disastrous policy. He is trying to get the dollars from foreign investment to bridge the Deficit. It is like the autorickshaw owner selling a ten percent share in his autorickshaw to another person. He can then use this cash to meet his increased daily expenditures. This is what Man Mohan Singh is trying to do. Japanese investors bought out Ranbaxy. The dollars came into our economy. This money was used to import Washington apples and French perfumes. But part of ownership of India passed into foreign hands. Other Indian companies were likewise sold. FDI was merrily coming in-for some time, at least. Then this came to a sudden halt. Foreign investors realized that Indian companies are running in loss. There are few buyers for them now. It is like the autorickshaw owner offering a 51 percent partnership. He says the partner can be the master and he the servant. But there is no taker because the autorickshaw has not been repaired for a long time and is running in loss. This is the reason why there has been no inflow of foreign investment despite the Government increasing the limits in civil aviation, multi-brand retail and insurance. RBI can do precious little in this situation. It can sell its forex reserves to hold the value of the rupee for some time. But these reserves will not last long.
Basic problems of the economy are bleeding of Government revenues via leakages and corruption; increased consumption by Government servants and spending for buying of votes; and using foreign investments for meeting consumption needs. The RBI is helpless. Inflation will be controlled but economic growth will suffer if it increases interest rates. On the other hand, growth will be helped but inflation will increase if it lowers interest rates. The RBI is trying to find a middle course between these twin problems. This is like a doctor trying to find a middle treatment for a patient suffering from diabetes, asthma and typhoid at the same time. The solution to these multiple problems lies in the hands of the Government; not RBI.

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