Wednesday, October 25, 2006


A warning- Most people might find this post a trifle boring.

First things first- I am feeling really proud about the fact that if the Tata deal goes through, technically, FDI from Indian exceeds that into. Of course from a financial markets perspective it might not be all that good, but one will have to wait and see. Of course, in the meantime media- print and otherwise will continue deflate your ego by running stories of how people affected by starvation in UP got cheques of Rs. 20, but then in our countries there is no dearth of such happenings- so one must find their little joys as and when they can.

One of the things that I have been thinking about lately is the state of the Indian economy. I mean, among other things I am paid to have a view on such things. At this point, let me first state that whatever follows are my personal views and not that of the organization that I represent *** feels really important, pushes his tie-knot higher, chokes***

Later this month the central bank sits down to review the monetary policy. It is something that every one around me is talking about. People are wondering if the central bank will raise rates. In my mind given the current state of affairs in the economy it is not really so important. First, when the economy is as overheated as India it is unlikely that any hike in interest rates will anyway have any effect on controlling inflation, much less GDP growth. I mean with everyone thinking of a hugely steep forward earning curve, it does not seem likely that anyone is going to think about deferring consumption. For instance, some really young people will take twenty-year loans to buy houses, thinking that they’ll repay it in the next 5 years or less, so they think that they are much less affected by a hike in interest rates. There are two reasons for that. In a country like ours one can either invest in assets or invest in a lifestyle (which is just a fancy way of referring to consumption). When consumer sentiment is thus, cash is really the most negative carry asset around. Leverage is the king. If people were to invest, they will look at asset classes that are potentially likely to grow in tandem with the real economy- read property, equities etc. Secondly, creation of assets like these often leads people to think that when the value of these assets appreciate astronomically, it is likely that further leverage is possible against the same. It is a vicious cycle, but then everyone just keeps consuming hoping that the guy next door is wiser. Actually, I don’t think anyone bothers at all.

What I was wondering is what does a central bank- whose essential means of managing the economy is monetary policy, do when faced with a situation like this. I mean tweaking interest rates is what a central bank can do best. Or so I thought. It seems my shortsightedness stems from the fact that I have not really seen enough economic cycles to list down the possibilities. A similar situation prevailed in India in the early nineties when we witnessed a similar boom in both equities and real estate. This was primarily fuelled by the emergence of the IT sector- an event unprecedented in the history of the country. No one really cared what money cost as long as they had it, and as long as they could buy that one scrip that every one had been talking about or that one apartment block which had swimming pools on every floor. These are times when the central bank looks up and sees the writing on the wall and it reads inflation. And monetarists don’t like inflation- especially this kind of inflation which comes with unbridled economic expansion.

Hiking rates at a time like this doesn’t really help. While it does little to contain private spending it does definitely make the cost of state borrowing higher, leading among other things, in a developing economy as ours, to a slowing down in creation of social infrastructure, as well as increasing the burden of welfare policies- thereby promoting the inequitable distribution of wealth. The solution is not to make money expensive, but rare. So, most central banks approach such a problem by containing liquidity. Now it is a fact that nothing much moves without money- so if equities are hot and speculative- assign a risk weight of 200% on bank lending to brokers, if housing is a bubble do the same to home loans- get the picture? Worse- intervene, buy the local currency from the market, flood the market with bonds. Nothing bothers banks more than two things- tight liquidity and low capital adequacy. Banks essentially rely on overnight funding for a lot of things and when those rates reach double digits, or their capital adequacy is in single digits panic sets in. they simply stop lending, for no price or love of money. And then everything comes to a standstill – trust me to the dyed in the wool central banker a tumble in stock markets or property prices is not always the biggest worry.

But this time things are definitely different. The economic growth is much more real, definitely more fundamental, more brick and mortar. This must be a big source of comfort to any policy maker. Industrial growth is hot, but I really don’t think credit growth is in line with it- it is a lot more benign. So while it might not be necessary to take all the drastic measures mentioned above – some of them have already been taken, it might just be the right time to hand over the baton of economic policy to the fiscal guys. Needless to say fiscal reforms are a much more structural means of economic development and policymaking. Greater transparency in the spending of the government, tighter tax nets and reining in of the “black” economy will do just as well, and go much further in an economy such as ours. More than that, while the private sector increasingly assumes self-sufficiency, it will be more important to bring about a quantum change in the magnitude and quality of spending in the social sector. And it will go a long way in ensuring that people don’t starve to death and those who survive starvation are not handed twenty buck cheques to feed a family of fourteen. Of course if all goes well, there might not be any family of fourteen in the times to come. Amen!!!


shuchika said...


reminded me of my days of eco hons.

u r at ur prolific best, may be u shuld just get married and make babies....

read ur story on limousine eyelashes. would discuss this in detail with u. when sloshed and mellowed.

and i know u have tagged me, it will take me a while to get untagged.

back from goa to the "here and now".

dazedandconfused said...

I knew a Prof Sinha who used to speak like this...