It's not usual for me to criticise public officials who are already down and out - as is the case with Duvvuri Subbarao, outgoing Governor of the Reserve Bank of India (RBI) today. But then, much of the criticism, perversely, is for exactly the wrong reasons: that he tightened monetary policy prematurely and too fast. And despite signs of some mea culpa in his farewell speech, Subbarao has left plenty of ammunition for me to expand upon.
But before the criticism, I should perhaps point out some of the positives. Despite the encomiums showered on his predecessor YVReddy, Subbarao was a marginally better Governor. Reddy was plain lucky in inheriting a very benign macroeconomic environment called NICE (non-inflationary credit growth) and he pretty much laid the foundations for India's financial ruin later by running a massively accommodative policy even during the high growth years. As I wrote in my post-mortem of the Reddy years almost five years ago, much of India's near stagflationary conditions today are the result of Reddy's loose monetary policies and Subbarao's decision to retain the script till it was too late.
Unlike his predecessor, Subbarao has showed signs of learning macroeconomics while on the job. In his initial years, Subbarao kept parroting the standard political response that "India's inflation is an outcome of high growth rates"; but towards the end of his tenure, he has changed his stance to reflect a better understanding of reality. He now says that "low inflation is a pre-requisite for sustained high growth rate". Though still short, it is indeed a position that is a lot closer to the economic truth. Reddy, in comparison, maintains his original response even today.
So, at least in a relative sense, Subbarao was a better Governor.
Now for the real story. Much of my criticism of Reddy is valid for Subbarao as well. However, in this article, I want to focus on two specific issues where Subbarao has tried to create an impression that is not indicative of the underlying reality.
First, that he stood up to the finance minister who wanted Subbarao to cut rates.
Second, that it was lack of reliable data that prevented him from acting earlier. Had the statistics been more indicative/real-time, he would have acted earlier and faster.
Both these claims are not true at all.
RBI Governor Vs Finance Minister
Too much has been written about the tug-of-war between the RBI and the finance ministry. I have often wondered whether all of this is a pre-planned charade to convince the public and the media to buy the story that the RBI is running a tight monetary policy.
But even if one accepts the fracas at face value, here's the clincher: anyone who believes that a tight monetary policy means keeping after-tax interest rates at several percentage points below the consumer inflation rate needs to start reading "Economics 101".
Moreover, the fact is Subbarao did indeed cut rates as recently as in May this year. So why this media impression that he maintained the independence of the Reserve Bank?
If at all I were to grant something on this issue, I accept that Subbarao did not crawl when P Chidambaram asked him to bend. But bend he did. No questions on that, and the double-digit consumer price increases we have seen for the last several years is testimony to that. He did little for the Indian saver, whose purchasing power he was the chief custodian of.
Lack of real-time data
Economics as a science is a far cry from its counterparts in the physical sciences where cause-effect relationships can be studied in real time, or at least in predictable timeframes. But because economics involves millions of moving parts, it is almost impossible to quantify the relationships accurately. This issue is even more acute in the realm of monetary policy where the transmission of policy decisions to market impact could take years.
What economics teaches is to find ways to think about outcomes and evaluate probabilities for the same. If, say, the Central bank expands the money supply at a rate faster than output, then it's inevitable that prices will rise, bubbles will form, misallocation of capital will occur and the ensuing market correction will lead to a recession. The above will most certainly occur, though it is very hard to predict which sector would attract additional capital and what timelines the boom-bust cycle will follow.
So for Subbarao to suggest that he did not have reliable data would be a bit off.He may have acted differently if he had taken cues from Adam Smith and Ludwig von Mises. Had he accepted the basic tenets of "free market economics", he wouldn't be in the predicament he is in today and India wouldn't be facing the currency crisis that is starring at us.
I am not absolving the PM or the FM for the reckless fiscal burden they have placed upon this nation. I am merely suggesting that Subbarao incentivised the political class into running such a programme by underpricing capital. Had he placed interest rates at levels where borrowings would have had to be met from savings, rather than through the monetisation of deficits, then the government couldn't have done what it has.
Shanmuganathan "Shan" Nagasundaramis the founding director of Benchmark Advisory Services - an economic consulting firm. He is also the India Economist for the World Money Analyst. He can be contacted email@example.com
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Updated Date: Dec 20, 2014 22:55:55 IST