Raghuram Rajan's maiden monetary policy

Rajan's maiden monetary policy produced a blizzard of instant commentaries. I thought I would wait and see how things pan out in the markets. The wait was worth it. I am not inclined to buy the contention that the policy is primarily about fighting inflation. I think it is more about maintaining currency stability.

Why do I say so? Well, the policy caused short-term rates to fall by a cut in the MSF rate. However, the hike in the repo rate will cause long-term rates to rise. The net effect should be an increase in banks' cost of funds and hence in lending rates. It cannot be otherwise if the policy is anti-inflationary. You can't have an anti-inflationary stance that causes lending rates to fall!

Rajan's maiden policy is undoubtedly anti-inflationary. But I would think that Subbarao's tightening in July was even more so. There was a rise of nearly 300 bps in short-term rates- and it was only a matter of time before long-term rates followed suit. That would have really slammed the brakes on growth. So Rajan has loosened policy somewhat, albeit at the short end.

If the focus had been primarily on inflation, then such a loosening would not have been warranted. The hike in the repo rate, which is meant to offset the cut in the MSF rate, is intended to maintain a decent differential between yields in India and those in the US ahead of tapering. It is a sort of preparation for the inevitable tapering of QE that lies ahead. Evidently, the RBI takes a rather grim view of what tapering would mean for India.

More in article in the Hindu, RBI focus still on currency stability.

Raghuram Rajan's diagnosis

Somebody sent me the link to an article on the Indian economic situation that Raghuram Rajan wrote just before he became RBI governor. It does not seem to have received the attention it deserves.

Rajan does not contend that the present situation is the result of serious economic mismanagement or that it can be rectified only through sweeping reforms, as many critics of the government do. Instead, his thesis - allow me to say that it is one that I have myself been peddling for quite some time- seems to be that the current situation is the result of a combination of adverse factors of a transient variety. They can be addressed through modest initiatives, it is not as if we need to unveil the entire panoply of 'second generation' reforms. I will let Rajan speak for himself:

In part, India’s slowdown paradoxically reflects the substantial fiscal and monetary stimulus that its policymakers, like those in all major emerging markets, injected into its economy in the aftermath of the 2008 financial crisis. The resulting growth spurt led to inflation, especially because the world did not slide into a second Great Depression, as was originally feared. So monetary policy has since remained tight, with high interest rates contributing to slowing investment and consumption.

Moreover, India’s institutions for allocating natural resources, granting clearances, and acquiring land were overwhelmed during the period of strong growth. India’s investigative agencies, judiciary, and press began examining allegations of large-scale corruption. As bureaucratic decision-making became more risk-averse, many large projects ground to a halt.

Only now, as the government creates new institutions to accelerate decision-making and implement transparent processes, are these projects being cleared to proceed. Once restarted, it will take time for these projects to be completed, at which point output will increase significantly.

Finally, export growth slowed, not primarily because Indian goods suddenly became uncompetitive, but because growth in the country’s traditional export markets decelerated.

 And how do we fix these?

The immediate tasks are more mundane, but they are also more feasible: clearing projects, reducing poorly targeted subsidies, and finding more ways to narrow the current-account deficit and ease its financing. Over the last year, the government has been pursuing this agenda, which is already showing some early results. For example, the external deficit is narrowing sharply on the back of higher exports and lower imports.

Every small step helps, and the combination of small steps adds up to large strides. But, while the government certainly should have acted faster and earlier, the public mood is turning to depression amid a cacophony of criticism and self-doubt that has obscured the forward movement.

There is no suggestion in the above of serious economic mismanagement on the part of UPA II. True, the fiscal deficit increased to an uncomfortable level post the crisis. But that is at least partly because the sharp slowdown in growth in recent years- caused, to  a large extent, by the sputtering of the Eurozone and the rest of the world- just could not have been anticipated. 

IAS/ IPS officers can now get medical treatment abroad!

I haven't seen any news item about the above, and I got to know about it when I read a great piece by Rama Baru in the Hindu:

The Government of India’s Department of Personnel and Training (DoPT) has decided to reimburse approved expenditure on treatment abroad, for a defined range of medical conditions, for officers of the Indian Administrative Service (IAS) and Indian Police Service (IPS). In doing so, it is extending to them a benefit available to Members of Parliament and officers of the Indian Foreign Service (IFS) when posted abroad. In addition, the travel and treatment costs for the officer and an attendant will be borne by the government. The order confers benefits over and above the entitlements under the Central Government Health Scheme (CGHS).

The existing rules, according to Baru, are as follows: 

Existing rules permit civil servants to secure reimbursement for medical treatment abroad or at a private hospital in India based on what it would cost to secure the same treatment in a private ward at the All India Institute of Medical Sciences (AIIMS), New Delhi.

If the government wishes to reimburse treatment of IAS/IPS officers at actual rates at a private hospital in India (and not at the AIIMS rate), it would be understandable. Allowing officers to go abroad for treatment is a different matter. The move, alas, will only reinforce popular perceptions of the collusion between politicians and babus in appropriating the spoils of government. The conclusion that most people will draw is that now that the politicians have done the babus a big favour, they can count on the babus to help them out where required.

I do not know whether MPs have raised this issue in parliament; if they have not, that would not be a surprise. Netas already enjoy the privilege that the babus will now get.

PS: After writing the above post, I checked the news online. It appears that medical treatment abroad will be permitted only for certain complicated ailments, which are mentioned in the order. Presumably, these are ailments for which comparable treatments are not available in India. This point is not properly reflected in the article I have cited. I have had to tone done my criticism somewhat and have modified my original post accordingly. I am hesitant to take my criticism back entirely. Which ailment requires treatment abroad is a matter of judgement and  such judgement, in our scheme of things, may end up being exercised independently of the merits of a given case.

Modi for PM: why did Advani want to wait until November?

Advani (and, until the last minute, Sushma Swaraj) is said to have asked the BJP top brass to defer Modi's anointment as PM candidate until November. Many people see this as mere pique on the part of the old warhorse or even a mere stalling tactic: put off the decision first, then get it spiked. Veteran columnist Rajinder Puri has a more plausible explanation:

What is so important about the November assembly results? Mr. Modi’s candidature as future PM raises some misgivings among potential future allies for a coalition government. That is why it is necessary for the party to obtain an outright or a near clear majority on its own if he is to be the next PM. Going by media reports, the reaction of its party workers, and opinion polls, BJP leaders are convinced there is a nationwide tidal wave in Mr. Modi’s favour that renders single party majority likely. However there is as yet no tangible evidence of this support translating into votes.......

....In November all the BJP units going to the polls are expected to comfortably win with or without Mr. Modi’s support. Except the Delhi assembly election in which the BJP sits in opposition. Delhi therefore will test in November how far Mr. Modi’s perceived charisma can deliver results. That is why perhaps Mr. Advani and Mrs. Swaraj want to delay Mr. Modi’s candidature as next PM till after the November poll. If BJP cannot win Delhi there could be serious rethinking and the party would need a prime ministerial candidate acceptable to potential allies who would be badly needed. 

Puri also suggests that, in the event that neither the BJP nor the Congress is able to form a government, there could be an effort to install Mr Pranab Mukherjee as PM. 

In November all the BJP units going to the polls are expected to comfortably win with or without Mr. Modi’s support. Except the Delhi assembly election in which the BJP sits in opposition. Delhi therefore will test in November how far Mr. Modi’s perceived charisma can deliver results. That is why perhaps Mr. Advani and Mrs. Swaraj want to delay Mr. Modi’s candidature as next PM till after the November poll. If BJP cannot win Delhi there could be serious rethinking and the party would need a prime ministerial candidate acceptable to potential allies who would be badly needed. - See more at: http://www.boloji.com/index.cfm?md=Content&sd=Articles&ArticleID=14933#sthash.D1TpHSWh.dpuf

What is so important about the November assembly results? Mr. Modi’s candidature as future PM raises some misgivings among potential future allies for a coalition government. That is why it is necessary for the party to obtain an outright or a near clear majority on its own if he is to be the next PM. Going by media reports, the reaction of its party workers, and opinion polls, BJP leaders are convinced there is a nationwide tidal wave in Mr. Modi’s favour that renders single party majority likely. However there is as yet no tangible evidence of this support translating into votes. - See more at: http://www.boloji.com/index.cfm?md=Content&sd=Articles&ArticleID=14933#sthash.D1TpHSWh.dpuf

What is so important about the November assembly results? Mr. Modi’s candidature as future PM raises some misgivings among potential future allies for a coalition government. That is why it is necessary for the party to obtain an outright or a near clear majority on its own if he is to be the next PM. Going by media reports, the reaction of its party workers, and opinion polls, BJP leaders are convinced there is a nationwide tidal wave in Mr. Modi’s favour that renders single party majority likely. However there is as yet no tangible evidence of this support translating into votes - See more at: http://www.boloji.com/index.cfm?md=Content&sd=Articles&ArticleID=14933#sthash.D1TpHSWh.dpuf

What is so important about the November assembly results? Mr. Modi’s candidature as future PM raises some misgivings among potential future allies for a coalition government. That is why it is necessary for the party to obtain an outright or a near clear majority on its own if he is to be the next PM. Going by media reports, the reaction of its party workers, and opinion polls, BJP leaders are convinced there is a nationwide tidal wave in Mr. Modi’s favour that renders single party majority likely. However there is as yet no tangible evidence of this support translating into votes - See more at: http://www.boloji.com/index.cfm?md=Content&sd=Articles&ArticleID=14933#sthash.D1TpHSWh.dpuf

What is so important about the November assembly results? Mr. Modi’s candidature as future PM raises some misgivings among potential future allies for a coalition government. That is why it is necessary for the party to obtain an outright or a near clear majority on its own if he is to be the next PM. Going by media reports, the reaction of its party workers, and opinion polls, BJP leaders are convinced there is a nationwide tidal wave in Mr. Modi’s favour that renders single party majority likely. However there is as yet no tangible evidence of this support translating into votes - See more at: http://www.boloji.com/index.cfm?md=Content&sd=Articles&ArticleID=14933#sthash.D1TpHSWh.dpuf

What is so important about the November assembly results? Mr. Modi’s candidature as future PM raises some misgivings among potential future allies for a coalition government. That is why it is necessary for the party to obtain an outright or a near clear majority on its own if he is to be the next PM. Going by media reports, the reaction of its party workers, and opinion polls, BJP leaders are convinced there is a nationwide tidal wave in Mr. Modi’s favour that renders single party majority likely. However there is as yet no tangible evidence of this support translating into votes - See more at: http://www.boloji.com/index.cfm?md=Content&sd=Articles&ArticleID=14933#sthash.D1TpHSWh.dpuf

What is so important about the November assembly results? Mr. Modi’s candidature as future PM raises some misgivings among potential future allies for a coalition government. That is why it is necessary for the party to obtain an outright or a near clear majority on its own if he is to be the next PM. Going by media reports, the reaction of its party workers, and opinion polls, BJP leaders are convinced there is a nationwide tidal wave in Mr. Modi’s favour that renders single party majority likely. However there is as yet no tangible evidence of this support translating into votes - See more at: http://www.boloji.com/index.cfm?md=Content&sd=Articles&ArticleID=14933#sthash.D1TpHSWh.dpuf

A spy novel- in more senses than one

Does the name Valerie Plame mean anything to you? Well, during the second Iraq war, she shot into unwanted fame as a CIA spy who was keeping tabs on Iran. And the people responsible for her getting unmasked were none other than those in the inner circle around President George Bush. They were upset that her husband, a diplomat, was not toeing the official line about Saddam Hussein having weapons of mass destruction- and sought revenge in the pettiest of ways by exposing his wife, who had spent many years living dangerously for the CIA. Plame's life became hell thereafter, with friends deserting the family and the couple getting death threats and what not.

At that time, Bush is said to have quipped rather callously that Plame was "fair game", meaning it was okay for his buddies to go after her. Plame wrote a book about the affair which was then made into a movie. The movie was a hit not least because the heroine in real life was everything you expect a lady spy to be - blonde, beautiful and very bright. Although Plame did tell interviewers that women, who were spies, did not necessarily conform to the James Bond version. As she put it then, the CIA had not invested a huge amount in her training so that she could go "horizontal".

Now Plame has come out with a spy novel, Blowback. Gillian  Tett reviews it in FT. Tett's conclusion is sobering:

The next time I read a newspaper story about western efforts to prevent Iran from obtaining a nuclear bomb (or Syria from spreading chemical weapons), I will ponder the twists of that Plame-cum-Pierson tale. If nothing else, it is a timely reminder that behind all the stories about Iran and Syria there is a second tale too: hordes of hidden young intelligence officers toiling away to make sense of events, in tough and (often) thankless jobs. And, for the most part, battling in complete silence.

QE reversal: does India face a financial emergency?

This is the question more than one reader of this blog has posed to me in recent weeks. I hope the appreciation of the rupee and the rise in the Sensex in recent days has assuaged their concerns somewhat. My own view has been that, yes, it is a challenging time but hardly cause for panic. The fall of the rupee below Rs 65 was a case of overshooting, so it is no surprise to find it oscillating between Rs 60 and Rs 65.

I guess the key question is: what happens when the Fed reverses QE? It is expected to make its intentions clearer on September 18. There is a view that this will unleash a tidal wave of withdrawal of funds that will devastate emerging markets, as in the East Asian crisis of 1997; India is in for a beating.

I had a look at the data on FII flows, and I am not persuaded. Since end May, when the Fed first gave indications of tapering the QE, only $3 bn has left the equity market (until September 6); most of the flight has been on account of investment in debt, $9 bn. Cumulative FII investment in equity is $137bn at the moment; that in debt only $28 bn. Even if more of the investment in debt leaves, that is not an issue. We face a serious problem only if there is an exodus of equity. The considerations underlying debt flows are quite different from those underlying equity flows. Debt will flee the moment interest rates in the US and the advanced world perk up; equity flows will flee only if growth opportunities change dramatically.

In the East Asian crisis, the exodus happened mainly account of foreign bank loans (which is similar in characteristics to FII investment in debt) and domestic residents taking their savings abroad, thanks to full capital account convertibility. (That is why the reduction in annual remittances of Indians from $200,000 to $75,000 is a sensible move). FII flows were not a crucial factor in the  East Asian exodus.

There are other differences as well between East Asia in 1997 and the current situation. I highlight these and make the point that emerging markets remain vulnerable in the long-term to advanced economy monetary policies unless they impose some restrictions on volatile capital flows- all this in my article in the Hindu, Easing troubles in the long run.

Raghuram Rajan's arrival

The  media went to town about Rajan's "rocking" arrival speech. Although Rajan had been careful to downplay expectations by warning that he did not have a 'magic wand' for India's problems, the media came close to suggesting that he was on his way to waving away India's economic woes. Some of the stuff I heard on TV sounded absurd: a century on debut; no, a century in the first session of play; and if this was his performance in the first session, what might one expect in the slog overs? Even by the abysmal standards of private channels these days, this was the pits.

Ok, so what did we have on the first day? Monetary policy, whether interest rates would be lowered or kept where they are, was deferred to the policy statement, which itself was deferred by a few days. RBI to offer low-cost hedging for banks that bring in NRI deposits in foreign currency. But this means the RBI is indeed focusing on currency stability and not just price stability. At the very least, commentators might have noted that Rajan was not strictly adhering to the ideology of focusing on price stability alone. 

Most of the announcements were about financial sector reform, mainly banking. New bank licenses to screened by a committee headed by Bimal Jalan (Jalan, if I am not mistaken, has had reservations about corporates getting into banking); a committee on financial inclusion under Nachiket Mor; SLR to be brought down once government finances improve, which is easier said than done.

Bank branch licenses to be made freely available except in the case of banks where RBI has concerns. Much was made of this but, as many bankers pointed out subsequently, getting branch licenses is not a problem today. Getting banks to apply has the effect of imposing a certain discipline on banks- they get to thinking through the commercial and other aspects more carefully- and it is also a means for the RBI to convey messages to banks (on say, customer service). So dispensing entirely with branch licensing might sound like "big bang reform" but may not be that.

What else? An inflation-linked bond. How will these be sold? Through banks? If so, what will be their motivation to push these at the cost of their own deposits. And, if it is sold through other agencies and works perfectly, what happens to deposit growth, the sheet anchor of our banking system? Gold bonds might be a better idea, so that idle gold is monetised and the need for gold imports is reduced but Rajan was silent on this. As for going after promoters with high NPAs, that's too much to expect in India's brand of crony capitalism.

It was left to FT to strike a cautionary note in its Lex column. How to stabilise the rupee is the main issue and this might require work outside the RBI; the G-20 declaration to create a fund for the purpose is a sign that all central banks feel helpless in the wake of the impending reversal of QE, not just the RBI.  Good to have a classy governor at the RBI but any euphoria is misplaced.

Subbarao rocks (or plans to)

Subbarao plans to learn Salsa after retirement. Other things on his wish-list include: making up with his mother-in-law (who is upset about soaring prices), watching matinee shows and studying math an linguistics. One thing he will not miss: having to say something profound every time he opens his mouth (he says he was asked about the world economy when he was at a wedding at 4 00 am!) For more cracks, see this post.