FROM BUSINESS WORLD OF 17 APRIL 2007
Rangarajan is
innocent
Reserve Bank’s
progressive tightening of monetary policy is drawing blood; many businesses are
feeling the pinch, and economists are beginning to fear that Venugopal Reddy is
aspiring to follow in the footsteps of his distinguished predecessor, Dr C
Rangarajan. When faced with rising inflation in 1995, Rangarajan had clamped
down on bank credit. Many companies that had ordered equipment could not get
credit to buy it, many that had expanded capacity could not sell their goods
because they could not give distributors credit, and many found their clients
canceling orders because they did not have money. Businessmen are wondering if
they are going to see a repetition of the bloodbath of 11 years ago.
In a speech to
Bombay Chamber of Commerce on 9 April, Rangarajan defended his action. He said
that the recession that following monetary tightening was due to the meltdown
in East Asia – and implicitly declared himself innocent. His defence is wrong
on timing. He began to tighten credit in late 1995; there was no sign of the
East Asian crisis till 1997. The troubles of Indian borrowers started in 1996,
on account of credit shortage, not lack of demand; the demand slowdown
spreading out from East Asia did not strike Indian shores till 1998.
Reserve Bank’s
handling of the East Asian crisis was also mistaken. It maintained the
Dollar-Rupee exchange rate at a time when East Asian currencies had been
devalued 30-70 per cent; thereby it gravely hurt Indian exports, and exposed
Indian industry to lower prices of competing imports than it would have been if
the Rupee had been devalued. Rangarajan very properly avoided this mistake, for
it was not his; it was that of his successor, Bimal Jalan. They were
responsible – though certainly not solely so – for the crisis of 1996 and the
ensuing slow-down, which ended only in 2003. The average growth rate in those 7
years half of the 9 per cent that we have recently achieved. If we had not lost
all that growth, we would have been 35 per cent richer today. Of course, it
would be wrong to assume that the path would have been smooth but for the
roadblocks introduced by Reserve Bank, or that other policy-makers would not
have made other mistakes. So 35 per cent is the upper limit. But 20 per cent
would be a reasonable estimate of the loss they caused.
The errors would
no longer matter since Rangarajan and Jalan long ago left their governorships. But
Rangarajan continues to be the Prime Minister’s most trusted economic adviser;
the errors he now makes have the potential to be magnified manifold. This is
why his spirited defence of the current tight monetary policy is important. According
to him, rising inflation, widening deficit on current account and 21%-plus
growth in money supply were indicators of an overheated economy. He thought it
important not to turn what is now a cyclical problem into a structural one; to
put it in simpler English, he meant that if inflation continues to be high,
people will get used to high inflation, and we will have permanently high
inflation – which would require perpetually high interest rates, depreciating
exchange rate and periodic payments crises.
Certainly, if
the choice were so put to them, most people would choose the yet unknown
effects of monetary tightening in preference to the frightening prospect
Rangarajan laid out. But his question was a rhetorical one; it already implied
its own answer. People should ask another question: is tight monetary policy
the only instrument available to the government against inflation? The answer
is no; there is also fiscal policy, and it is superior under present
circumstances. For one thing, tight monetary policy acts only against
investment and inventories, whereas fiscal policy can work against all
components of demand, including consumption. For another, monetary policy has
the strongest impact on banks and their borrowers, which are mostly small
businesses; taxation can impact the incentive of all investors – big companies,
small businesses, and personal borrowers. There is something Rangarajan has
missed out in his policy prescription; and he is too good an economist to have
missed it out inadvertently.
