Growth, Exchange Rate & Expectations

 Q&A with Outlook (L Nayar)

Q1: Why there is such a marked change in perception about India's growth prospects and improvement in Indian currency since RBI governor Raghuram Rajan took over?

A1: these are two different questions with opposite answers.

 Q1a: Why there is a change in perception about India's growth prospects.

 A1a: Growth prospects have worsened as shown by the GDP data for the first quarter of 2013-14 (April-June). Consequently all forecasters, including the government related bodies, have reduced their forecast for 2013-14 by 1% point or more.

 Q1b: Why there is such a marked change in perception about India's currency and improvement in Indian currency since RBI governor Raghuram Rajan took over?

A1b: There are two reasons. The movement of the dollar above Rs65 was clearly due to pessimistic expectations, a problem that economist call overshooting. Raghuram Rajan the new RBI governor has, through his maiden speech on the first day of taking over at RBI, effectively used his global reputation to remove irrational fears and re-establish RBI credibility. This brought the dolrar below Rs65.  The further movements below this level are due to small positive developments on the external front, like a narrowing of the trade deficit and stabilisation of expectations about future fed actions.

Q2: Have the fundamentals changed in anyway or is it only a change in perception? If so will the change in perception including among private investors bring cheer to Indian economy?

A2: It is due to a change in perceptions of short term financial investors alone. There is little or no change in the perception of long term investors, and the decline in GDP growth coupled with marginal improvements in balance of trade have a negative effect on balance.

Q3: Can a single person - the RBI governor be the change agent or is it unwarranted expectation?

A3: The RBI Governor can only change perceptions regarding aspects that are covered by RBIs mandate and act within its own mandate, which is monetary stability. The governor can also play a more activist role in financial market reform, which will have a medium term effect on efficiency & growth. Raghu's speech gives an indication that he intends to play such a role to promote faster financial development. Beyond this the expectations are unwarranted.

Modi (anti-) intellectual Icon?

Socialist Ideology

     Since the ascendance of Shri Jawharlal Nehru, our intellectual discourse has been dominated by various versions and adaptations of Socialist ideology. The high priests ('Brahmins') of this ideology are the "left intellectuals" who dominate the public debate.  Many of us thought that the 1990s reforms, their success in accelerating growth and the consequent reduction of poverty would gradually change the discourse.  This optimism was premature, as the "left intellectuals" successfully fought back and re-established their primacy during the UPA regime (I & II).  The "socialist ideology" is so pernicious because it crowns the "left ideologues" as the arbiters of public morality (the prosecutor, judge & jury).  Their narrative is so widely believed, that if you oppose the left you risk being typed as uncaring of the poor, the weak and the humble!  Thus even 'conservative' or so called 'right wing' political parties have internalised the "left intellectual" narrative.  This uniformity of intellectual and political narrative is not good for the country. The Monopoly needs to be broken.

Competition

      A recent book on the role of institutions in economic welfare and growth concluded that "Competitive Politics" are as important as "Competitive markets" for sustained economic development and growth. This is particularly so in an Open Democratic country like India. India needs an alternative narrative of economic growth and welfare, that politically challenges the monopoly of the "left intellectuals." Though it is dangerous for a poor country to simple copy what advanced countries have done, the interplay of competitive markets and social policy in Scandinavian countries is instructive, provided we clearly understand the difference in institutional conditions and circumstances.

Iconic Challenger

    From my perspective, the most interesting thing about the rise of Shri Narendra Modi on the National Stage, is the challenge that he poses to the "Socialist ideologues."  The seriousness of the challenge that he poses, can be gauged by the minute dissection of his every statement and action and the virulence of the "left intellectuals" attack on everything that he has said and done.  Being from a poor family, a backward caste, an uneducated child who educated himself as an adult, a self made man, free of the corrupting influence of family rapacity, who has never used his humble background or caste to win votes (though he has used his religion). More than any other potential candidate for PM a man of the people. A Chief minister of one of the richest and faster growing States in India, who has been re-elected three times. A non-intellectual, virtually an anti-hero in intellectual context. 
    In sum, Narendra Modi is almost an iconic challenger to the "left intellectuals" and their ideological dominance of the political discourse. The question is whether this non-intellectual will be the leader who overthrow the monopoly of the "left intellectuals" and create a new "governance and growth," "right of center" national narrative to compete with the "socialist ideology"?

Conclusion

  From the very limited information available till now (opinion polls, media stories of writers' interaction with public) I conclude that Shri Modi has a better than even chance of becoming the next Prime Minister of India and of changing the political narrative of National welfare, governance and growth.[1]  What else he may do (good or bad) needs much more detailed analysis.

[1] For the possible direction in which the narrative may be changed see, Virmani, Arvind, "A New Development Paradigm: Employment, Entitlement and Empowerment, Economic and Political Weekly, Vol. XXXVII No. 22, June 1-7, 2002, pp. 2145-2154. [  NewParadigm4nf ]

Monetary Policy And Financial Reform: RBI under Raghuram Rajan

Background

     Despite predictions of a bottoming out of economic growth, the rate of growth of the Indian economy fell to 4.4% in Q1 of 2013-14 from 4.7-4.8% in the previous two quarters.  With the government and the Congress party (UPA II) focused almost exclusively on welfare laws and expenditures,  any remaining hope of decisive action on investment-growth enhancing reforms was rung out of the markets.  This led me to say a week ago that the Government-RBI had boxed themselves into a corner with little room for policy maneuver, and only an unorthodox fiscal-monetary policy, the “Macro-twist” accompanied by bold reform could now get the economy out of this situation.  In this context the appointment of Prof Raghuram Rajan as Governor of RBI was the only silver lining on the dark clouds hanging over the economy.  Raghu, on the day of taking over as Governor of RBI on 5^th August, 2013 used his international credibility among the Global Brahmins of Money and Finance and the World’s Central Bank Governors to expand the box, the range of options available to the RBI.

RBI under Raghuram Rajan

    Raghu’s first speech as governor(4^th Sept 2013), coming as it did on the day that he took charge,  surprised with the  speed with which he spelt out his vision for the RBI. In hindsight, it actually reflects the fact that he is probably the first RBI governor (in my memory), who in a manner of speaking was groomed for the job. Six years ago he was appointed chairmen of a committee on financial sector reforms and developed his ideas on banking, financial and institutional (RBI) reforms needed in India.   Since then he has been an external advisor to the PM, allowing him to keep in touch with the problems facing India.  Last year he was appointed as Chief Economic Advisor, to gain experience of the inner workings of the Ministry of Finance and the Government in General.  He was thus in a position to ‘hit the ground running,’ and he did so!

Given this background, including his international standing as a star economist and the indications he gave in his first speech, I predict that Governor Rajan will follow a two pronged approach to Monetary and Financial policy

(1) He will adopt a modern, neo-conventional monetary policy, and The epitome of ‘conventional monetary policy’ was “inflation targeting” based on the assumption that in the long run this is also the best policy for full employment/maximum Output (growth).  The “Neo” refers to the lessons learned by the Global financial-monetary czars about systemic risks and macro-prudential regulation, after the Global financial crisis (which he was the first to warn about).  Having, warned him about the problems of “inflation targeting” in India and heard his response, I would expect him to adapt it to Indian conditions and move cautiously in implementing this policy.  The new committee under DG Urjit Patel will likely draw up a road map for implementing this and supporting institutional reforms (like the ‘Monetary Policy Committee’).  As he said, he will spell out his monetary policy stance to current and expected  developments, like the unwinding of QE3, in his monetary policy statement on September 20^th , 2013

(2) He will forcefully pursue liberalization of financial markets, including foreign exchange markets and banking, institutional reform of the RBI & other financial institutions, and universalization of modern payment systems, banking & financial instruments (inclusion). He has already announced a number of specific liberalization on banking and foreign exchange.  Liberalization and promotion of competition are risky at a time of low growth and high uncertainty.  Thus timing and sequencing of liberalization measures needs to carefully weigh the gains against the risks: The latter can only be minimized through skillful but ruthless prudential regulation, e.g. on “Non-Performing Assets” (NPAs) and “ever-greening”.  Therefore he has already warned that he may have to take unpopular actions.  Some of the measures, such as new Banking licenses to industrial houses can also be politically contentious.  He has therefore wisely set up a committee under former RBI Governor & Member of Parliament (MP) Dr. Bimal Jalan, to act as the last word on new Banking licenses.

The RBI has been excessively cautious on the use of new technology to spread modern payment and banking systems.  Since the introduction of mobile pension payments in rural South Africa  and MPESA mobile cash in East Africa, I have been pushing the RBI to adopt these systems. As Raghu’s committee strongly advocated inclusion, I expect these to be speedily introduced in India.  This, and his committee’s innovative proposal to introduce ‘tradable priority sector lending commitments’ and other new ideas for inclusion will be chalked out under the ‘Nachiket More’ committee.

Conclusion

    In my view, these reform measures are Raghu’s answer to those of us who have argued for giving greater priority to economic growth.  With the reforms log jam persisting in Delhi, he is implicitly saying that he will follow a relatively conventional monetary policy and it is up to the government to do its part on the fiscal and structural policy side to promote growth.  At the same time he will try to help market expectations and confidence through a new more aggressive financial reforms policy, which will promote efficiency, investment and growth in the medium term.  Having expanded the range of Macro options, through his personal credibility and decisive start, it is now up to the government to act. 

[Note: This article was written on September 5th 2013, a day after Raghu's maiden speech, but has been pending with a newspaper since then.]

Faces of Corruption In India

Overview

   To understand corruption in India today it is useful to analyze it along two dimensions.  Economic and Institutional.

The main Economic categories (from a corruption perspective) are, (i) Government purchase of Goods and Services (including government employment). (ii) Production and sale of Goods and Services by Departmental Public Undertaking and Public Sector Units.  (iii) Natural Resource Rents: Natural resources include all minerals (including  coal, oil & gas), Land and Electromagnetic Spectrum. (iv) Natural and Artificial (policy created) Monopolies & PPP contracts related to these.  Networks such as electricity T&D & rail lines, airports, major ports and dams are natural monopolies. State Electricity production, Railway services (INR), Coal India, Dual use items of Defense production are monopolies created by policy & can be made competitive by policy change. PPP contracts for these as well as for Social services exclusively produced & supplied by government take on the character of artificial monopoly when good auction procedures are not used.   

The main Institutional dimensions are, (a) The “Lower Bureaucracy:” The ‘State government’ machinery dealing with repeated routine economic & social activities. This is the machinery we deal with as citizens, as workers, as employees, as self-employed, as small businesses, as NGOs and large corporations as tenants or house owners, as land owners or rentiers.  This is the government whose functionaries, often referred to as “babus,” we all interact with, in one way or another, in every sphere of activity. Also includes the entire local government (Nagarpalikas & Panchayats) & a part of the Central bureaucracy (non-IAS, IPS) that operates at State-City level (e.g. Customs, Income tax, Central excise). (b) The “Higher Bureaucracy”(Officers of the central services like IAS, & equivalent parts of State services)  The decision making process for deciding on policy and implementing one off or unique procedures that have to decided anew every time. This is more high level decision making. (c) The criminal justice system. This is the notorious “politician-criminal-police” nexus that actively thwarts the “rule of law,” and believes it is above the law and behaves as if the constitution of India does not apply to it. Judges who take bribes to give knowingly wrong decisions should perhaps be seen as part of this.

With some danger of over-simplification, much of the first two economic categories of corruption is institutionally carried out by the lower bureaucracy, with systemic payments (bribe shares) moving up the system, while much of the third and fourth economic categories of corruption is done at the Higher bureaucracy level (with Lower Bureaucracy involvement only when needed) either with knowledge of or under the direction of the political bosses.

Economic Dimensions

There are four major categories or sources of government related corruption in India.

Govt. Expenditures/G&S Purchases

Goods and Services Purchases that constitute the expenditure side of the budget of government at every level.  This includes wages & salaries and therefore hiring and recruitment and contracts for construction and maintenance of roads etc.  My informal inquires & reading suggests that the cut that government as a whole takes (shared between the functionaries & the bosses) has gone up progressively from about 15% in the 1960-70s to a range of 30% to 50% in the 2000s (% depends on nature of the G&S).

Public Production & Sale of items that can be produced by private producers and sold in market.  These include all the Cetral government and State government owned.

       There is a massive system of corruption in government expenditures and purchases in which all levels of workers are involved,  from the lowliest sweeper  & chaprasis, through petty clerks,  dealing hands inspectors & superintendents through officers and politicians.  In this well oiled machinery the unchanging faceless bureaucracy collects the bribes and shares it up to the officer and political level.  It is my understanding that a new politicians or concerned State minister does not have to ask for anything, it would be delivered to him whether he wants it or not. This is the part which is so pervasive and systemic  that only a major institutional reform can  reverse the process.

Natural Resource Rents

Natural Resources such as Urban Land, minerals/oil, Spectrum, Aquifers. Theoretically these resources are the common property of the citizens. With few exceptions government at different levels [Local (Nagarpalika, Panchayat) State, Central] control all natural resources through multiple means and can manipulate policies, rules, procedures & enforcement to extract resource rents for themselves and those who help them cheat the people out of these resources.

    These are generally large case by case decisions and are therefore likely to be controlled at relatively higher levels of State, Central Governments.  An economically sound way to reduce natural resource related corruption is to make it compulsory for government to sell or lease all natural resources through an auction procedure that is designed to facilitate a large number of bidders.  These auction procedures have to be simple, well designed and understood, otherwise the corrupt will manipulate these auctions too.  There are a host of complication related to Urban land that have to addressed separately in detail. One of the most critical is the way “Land use” is determined and changed. Manipulation of this aspect can be source of massive corruption.

PPP for Natural (or Created) Monopolies

  PPP Contracts related to "Natural Monopolies" or artificially created "monopolies".  Manipulation of terms and conditions and the contracting process can be used to give contracts to favored parties. In some cases, an honest person knows that the strict terms of the contract cannot be fulfilled without making losses. The dishonest know that they can later bribe and get terms changed and therefore apply.

Institutional Dimensions

  Lower and Upper Bureaucracy: To deal effectively with corruption, it is necessary to distinguish between the lower bureaucracy and the institutionalized-routineised, entrenched corruption that has become a way of life for the ‘Babus’ and the case by case corruption at the higher levels in which manipulation decisions have to be made case by case or for groups of cases.  The latter involves the active participation of the government ministers.

 Violations of Law: (a) Major violations include violations of criminal law that come under the rubric of "Politician-Criminal-Police" nexus.  Also include violations of govt. rules & regulations that could cost human lives or cause serious damage to health.  (b) Other violations are related to violation of government rules, regulations and procedures on day to day economic and personal activities.

Conclusions

    Corruption is Hydra headed monster that has to be addressed at different levels.  It requires political, judicial, legal, police and bureaucratic reforms

Monetary Policy & RBI

Q&A with Bloomberg on August 3, 2013

Q1: How do you assess India's current economic situation? Can you think of an adjective or a phrase to define India's current situation?

A1: India’s current Economic Problems are due to widespread Growth Complacency following the successful recovery from the Global Financial Crisis.
Q2: The U.S. Fed tapering is explained as one main reason why India is seeing a huge pain in terms of outflows and plunge in the rupee. What's your outlook on the Fed unwinding and what does that mean for India? Do you see it stretching over a 1 to 2 years timeframe and, if yes, what does that mean for the entire world, including India?  Do you see India going through a prolonged period of pain?
A2: The main reason for the Rupee depreciation is the loss of competitiveness of the Indian economy due to high inflation and low corporate investment, resulting in appreciation of the REER. With the rupee at 65/$ this has been offset for the time being. The Fed unwinding was a trigger for the depreciation.  The uncertainty arising from the Fed will reduce considerably once the new Fed Chairperson is selected by President Obama. However, another US interest rate rise, with its effect on capital outflows from Emerging markets is still possible.

Q3: How serious the current crisis is with the rupee plunging, IIP in negative, CPI inflation in double digits and widening deficits? Do you see a possibility of a recession or recession-like or stagflation or stagflation-like situation in India?
A3: The economic situation is extremely serious.  Barring bold policy reforms, I expect continued slow growth and persisting CPI (new) inflation in the 8-9% range.

Q4: What's your outlook for economic growth? Do you see a protracted growth slowdown in India?
A4: I first coined the word “Growth recession” to describe the Indian growth slowdown in 1997. I expect growth to bottom out in Q2 of 2013-14 (Q3 of 2013), but a very slow and protracted recovery, in the absence of bold policy reform to restore macro balance and revive corporate investment and growth.

Q5: What's your outlook for the rupee? Where do you see the rupee by the end of December? Do you see it touching 70 against the dollar? Or even lower than that?
A5: I think there is a high probability of the rupee ending 2013 between Rs65 –Rs70/USD.  However, I cannot rule out the possibility that another negative external shock could push it above Rs70/USD.

Q6: The rupee has continued to fall despite a slew of measures by the RBI and the government. What does the steep decline in the rupee indicate about the management of the crisis? What are the markets signaling about the management of the crisis?
A6: The depreciation of the rupee to about Rs 65/dollar was primarily due to the loss of competitiveness.  However, the attempt to keep it from moving to that level through various control measures backfired, with markets interpreting it as a return to old discredited methods of the 1970s.  the loss of credibility made it more difficult to keep the rupee from overshooting above Rs. 65/USD.

Q7: Why is India in such a mess? As an economist, who has analyzed India for more than three decades now, what do you think has gone wrong?
A7: There are four reasons (each of which I had warned about in 2009 my last year as CEA, MOF).    (a) High growth cannot be taken for granted and must be nursed through pragmatic measures to deal with bottlenecks and shocks.  The failure to institute policy regulatory & institutional reform measures has led to a down trend in growth.  (b) Old and new problems in the agriculture supply chain have resulted in inadequate supply while demand accelerated with per capita income resulting in and high food inflation. (c) Delay in pulling back on growth of government consumption (including subsidies) and reducing revenue deficit, and thus crowding out Govt.  investment and  leading to a demand bubble in 2010-11 (with its bursting from subsequent external shock). (d) Encouraging Capital inflow surge, instead of restraining it with predictable appreciation of the REER and consequently on Balance of Trade and Current Account Deficit.  

Q8: How do you think the Reserve Bank of India has tackled this crisis? What can the RBI do in such a situation to support growth and contain rupee's plunge and curb inflation?

A8: Reserve Bank assumed that the depreciation was due to credit financed speculation and tried a mix of traditional control measures and conventional liquidity tightening. As the move from Rs 55/USD to Rs. 65/USD helped correct the earlier appreciation (inflation differential) it was unsuccessful in doing so.  It also weakened its credibility.  In my view it should have let Rs depreciate to a point between Rs65 and 70, that it could successfully intervene to demonstrate effectiveness and give a message to speculators.

Q9: Do you think, we are in a somewhat a similar situation the U.S. faced in 70s (Nixon era) when it had a huge cad problem, that resulted in the dollar crumbling and forced Paul Volcker to raise rates aggressively? Do you see Volcker-like tightening as the final solution to get a grip on the currency crisis?

A9: I believe that a conventional monetary policy of raising interest rates in response to a rise in US rates will lower growth rates without stemming rupee depreciation or slowing CPI inflation which is largely due to Agriculture.  I have suggested an unconventional policy called the Macro-Pivot that would reduce government expenditure (including subsidies) to reduce government dis-saving and demand for non-tradables and loosening monetary policy to promote private investment and demand for consumer durables.

Q10: Do you think that the RBI is done with the rate easing cycle? What will be the future moves  towards tightening the rates (having already raised MSF and bank rate)?

A10: RBI’s policy will now be determined by the new RBI governor. We will have to wait till he takes over and signals his intentions.
Q11: What more do you think the RBI and the government can do to contain the currency crisis?

A11: The immediate crisis arising out of the rise in US interest rates has been contained.  Further shocks can only be dealt with by taking control of monetary policy (flexible exchange rate) combined with the “Macro pivot”.

Q12: Dr. Rajan in his 2009 financial reforms report advocated for a complete overhaul of the economic policy making in India, including, inflation targeting and operational freedom for the RBI and government cutting down deficits. Do you think Dr. Rajan will be able to push for the implementation of those reforms? What will enable him to do that or what will prevent him to do that?

A12: Raghuram Rajan as RBI governor has the authority to carry out all financial reforms pertaining to the RBI itself.  He can also influence the financial reforms pertaining to other financial regulators and the finance ministry, as historically RBI is viewed as more resistant to change. He has the blueprint of the committee that he chaired 6 years ago.  However, I would strongly recommend against introducing “inflation targeting” at this sensitive time.  Raghu will have little influence on what the government does on the deficit front.

Competitive Markets and Social Change I

Competitive markets can change social attitudes.  Viewed from a social perspective a competitive market is impersonal.  It does not care about who you are or what you do. All it cares is how much money you are willing to spend on the good or service that the producer wants to sell.  It is indifferent to the caste, creed, color or religion of the buyer.  As the saying goes, "markets don't care about the color of the money".  If you don't believe it, ask anyone who has been to a MacDonald, Pizza hut or Cafe Coffee day. In sum, competitive markets are very egalitarian with respect to every social dimension, with the possible exception of class.  Though there are products and services that capitalize on the notion of "high class," mass markets by definition depend on volume and cannot afford to make such distinctions.

    A competitive market for a good or service is something more.  It is a "positive sum game".  Every body benefits from the availability of new products and services, cost reduction and improved quality and enhanced productivity that results from competition. That is, both buyers and sellers can benefit from the transaction,  This is particularly noticeable when a new product comes into the market.  By now the classic and much studied example is that of the ubiquitous cell phone.  Both the millions of consumers and the telecommunication companies that supply the cell phone services have benefited tremendously from this new service.   No seller of SIM cards or recharge service cares whether the customer is a Dalit or Brahmin, Black or White, Hindu or Muslim - He is only concerned about how much money you want put into his pocket.

  Similarly the rate of growth of competitive markets determines how widely and deeply the benefits of competitive markets are distributed.  The faster the growth the more visible is the benefit and the easier it is for the common man who does not understand words like 'competitive' and 'positive sum' to see and feel the egalitarian nature of markets.  Beyond a certain per capita income level and above a certain growth rate, even those who have limited personal experience (little discretionary spending) can comprehend the difference between traditional hierarchical social structures and the egalitarian sociology of the market.  Even those who have just crossed the threshold of subsistence are able to see the difference it is making to others who were only a little better situated in the existing cast and other social hierarchies.  This is the beginning of social change.  This in my view is what has started happening in India.