:: Paranjoy Guha Thakurta

RBI gets a pat as global downturn gets worse

Paranjoy Guha Thakurta

April.22 : For the first eight months of 2008, relations between North Block and the Reserve Bank of India (RBI) were often strained. Though the country’s central bank and apex monetary authority is supposed to be autonomous, everyone and his brother knows that the governor of the RBI has to often "consult" if not bow to the wishes of the mandarins of the all-powerful Union ministry of finance in New Delhi.

Till September, the RBI was sucking liquidity out of the banking system to contain inflationary expectations — that was considered not just politically correct but also a prudent thing to do economically since the rate of inflation as measured by the official wholesale price index had risen sharply to hit a 13-year high of almost 13 per cent in August. By following a contractionary monetary policy, the RBI hardened interest rates. This was not liked by captains of industry and their sympathisers in the finance ministry, all of whom bitterly complained that the economy’s growth potential was being constricted because the RBI was allegedly following a myopic monetary policy.

Although they publicly never uttered a word against each other, towards the fag end of his tenure as RBI governor, Dr Yaga Venugopal Reddy was apparently not exactly best of friends with the then finance minister Palaniappan Chidambaram. Soon after Dr Reddy was succeeded by Duvvuri Subbarao in early September, another officer from the Indian Administrative Service (IAS) who had earlier served as finance secretary, Wall Street collapsed and its ripple effect was felt all over the world. Call it a coincidence, but the fact is that under Mr Subbarao the RBI did a complete somersault, a U-turn on monetary policy by pumping in huge volumes of liquidity (an estimated Rs 3,00,000 crore in four months) and softening interest rates.

Should Dr Reddy have started easing the flow of liquidity before his successor sat on the chair he had occupied for five years? Did the hardening of interest rates in the first three quarters of 2008 really restrict the rate of growth of industrial production or would this have taken place anyway because of the global recession and the overall economic slowdown? One could debate these questions endlessly, but the fact is that the RBI has now come in for effusive praise from none other than Nobel Laureate in economics Joseph Stiglitz, who had served as economic adviser to former US President Bill Clinton and chief economist of the World Bank (before becoming a critic of its policies).

Speaking at a conference on India at Columbia University, where he teaches, Dr Stiglitz said an important reason why India is "one of the least dark spots" in the world at present is on account of the RBI resisting "political pressures" to "deregulate" the country’s banking and financial sectors. It is significant that the Left too wishes to take credit for resisting the efforts made by the United Progressive Alliance (UPA) government — read Prime Minister Manmohan Singh, former finance minister P. Chidambaram and deputy chairman, Planning Commission, Montek Singh Ahluwalia — to integrate India’s economy more closely with the result of the world and make the working of the banking and financial sectors more "market friendly" in the name of economic "reforms".

Here’s exactly what Dr Stiglitz remarked: "Now I think the financial markets are thankful that India’s central bank did resist those pressures. The result is that India’s financial markets are in better shape than they would have been if the RBI allowed wholesale deregulation (the way the) United States has done…"

He added that although developing countries, especially India and China, are doing much better than the rest of the world, including the US, one should not believe that the US economic downturn would not affect emerging economies worldwide. He said that till a year ago, there was talk of "decoupling", meaning that a global economic downturn would not spread to countries like India and China. "I always thought that that was a myth", he said.

When asked how long the global crisis would continue, he said there were actually two crises: "A financial crisis and a conventional economic crisis. When the origin of the crisis lies in the financial sector, typically, downturns are deeper and longer and this is a very severe, serious financial sector crisis. And we can expect a very long and difficult period of recovery".

Dr Stiglitz justified his pessimistic view and pointed out that whereas Asian countries were able to recover quickly after the 1997-98 financial crisis, this time round the recovery process would be drawn out because export markets in the West have been shrinking. His view is supported by Nouriel Roubini, among the few economists who had anticipated the scale and magnitude of the recession in the US economy and its impact on the rest of the world, who wrote on April 15 that the worst is not yet over and that recent rises in share indices were in the nature of a "bear market rally" or a "dead cat bounce", adding that "economic recovery everywhere will be weaker and will take longer than expected".

The US government’s Labour Bureau has stated the unemployment rate hit a high of 8.5 per cent in March, indicating that an estimated 5.1 million Americans had lost their jobs since December 2007. The economic situation in India is hardly bright even if one derives small comfort by arguing that what we are witnessing here is an economic "slowdown" and not a recession that implies a decline in economic activity. The Federation of Indian Exports Organisation has not changed its estimate that there were 10 million job losses in export-oriented industries in the country till March.

One does not envy the new government that will be installed in Delhi. The tasks ahead are really tough.

Paranjoy Guha Thakurta is an educator and commentator based in New Delhi