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Imagination, Flexibility and Speed

Omkar Goswami


Dear Governor

You are the second of the last three RBI governors who hasn’t had the luxury of easing on to the seat. When Dr. Bimal Jalan took over, the Asian financial crisis was at its height; the rupee was rapidly spiralling down — from Rs.36.31 per US dollar on 5 November 1997 to Rs.39.57 by 15 December; everyone was shorting the currency expecting a hasty and disorderly decline to beyond Rs.40; and earlier efforts at maintaining an orderly depreciation had come to naught. As the editor of Business India, I recall writing a ditty: “From crashes to crashes / Bust to bust / If Thailand don’t catch you / Then Indonesia must”.

Like Dr. Jalan, you too have moved to the RBI in extremely difficult times. Probably far more dire than what Dr. Jalan faced. On your sixth weekday at the RBI, the already battered financial world saw Merrill Lynch being taken over by Bank of America and Lehman Brother’s filing for bankruptcy under Chapter 11. As one writes, Washington Mutual is about to tank; while the insurance giant AIG desperately waits for a US Federal Reserve bail-out. Everyone expects UBS to implode. And I suspect that at least one other European bank will soon come up with seriously bad news. In a milieu of incredible fear where no one trusts anyone, global liquidity has gummed up like we have never seen.

There is also a story of hubris and how success blinded a 30-year old veteran of Wall Street. Only a short while ago, Dick Fuld, Chairman and CEO of Lehman Brothers wrote to Warren Buffet, trying to lure him to investing $5 billion for 33% of the company’s stock. Here are excerpts from Fuld’s letter to Buffet, which I was forwarded by a friend:

“Our firm is poised to return to greatness, and many of Bear’s clients are coming our way… I have spoken to both the Treasury Secretary and Chairman Bernanke, and they are prepared to assure you personally that Lehman will continue to have access to the Fed’s discount window for many years to come… As such, our firm cannot fail in the traditional sense… This is an investment circumstance that rarely presents itself in the lifetime of any investor; even one as successful as your own.”

Buffet declined. Barclays pulled out, followed by Bank of America. And Lehman Brothers filed for bankruptcy on 14 September.

What does this mean for India? For our monetary and liquidity policy? What are the imaginative and creative options open to the RBI?

Despite a good India story, liquidity will seriously dry up in the next six to twelve months. Investor confidence in Asia is falling. In the second week of September, emerging market equities saw a net outflow of $2.2 billion. India is no exception. Between 1 July and 16 September this year, the net FII outflow on account of equity has been $1.85 billion. Thankfully, this outflow has been compensated by a more or less equivalent inflow of funds for debt securities. However, with the sharp depreciation of the rupee, the advantages of interest rate arbitrage have dried up. So, one could expect net outflows on the debt account as well.

Many believe that the trend of net FII outflows will continue for a while as growth forecasts for Asia, especially for India and China, start getting cut for 2008 and 2009. Indeed, one expects a period of flight to safety as global investors move to US treasury bills, euro bonds and attractively underpriced US equities.

How can we deal with this scenario?

There are three levers that we need to work on in a concerted manner. The first is to publicise the India growth story in a calm, collected and data-driven manner. We have several positives in our favour. Real GDP growth of 7.5% for a continental sized economy is not to be trifled with, especially in these times. We need to demonstrate the robustness of this growth process; of how a base-line growth of at least 7.5% is a given; and what this means to domestic demand, household savings and investments over the next decade. It is a very good story, and one that needs telling in a mature way. Economists, industry associations, analysts, newspapers can do their bit. This is not spin. It is the truth of India’s groundswell of growth.

The second lever involves the economic ministries. This is the time to fast forward all the reforms that can be passed through administrative action. Doing some of these at a time of global turmoil will demonstrate the State’s resolve to go ahead with reforms. I don’t want to list each of these. We all know that there are many.

The third lever involves the RBI. In my opinion, this is no time for being an ultra-conservative inflation hawk. We have done a great deal in squeezing out liquidity, raising interest rate and tightening credit to demonstrate our anti-inflationary bias. Thankfully, inflation is going down. Further restrictions will not accelerate the rate of decline; instead it will further restrict liquidity and choke off growth.

Therefore, my gratuitous request is that you consider easing up a bit in October, if not earlier. For instance, you could reduce the cash reserve ratio by 50 basis points and cut the repo and reverse repo rate by the same amount. These moves can be justified thus: “We are seeing a gradual softening of inflation in India. Equally, we are seeing a severely tightened global liquidity situation. In this scenario, and overall slowdown in global growth, there is a case for creating a monetary fillip to India’s growth prospects for 2008-09 and beyond. We will, however, closely monitor the price situation and intervene if considered necessary”. Or something to that effect.

Believe me, this will inject much needed animal spirits in the country’s entrepreneurs, bankers and capital markets. Of course, diehard, doctrinaire monetarists will hate this suggestion. To them, and to you, I have this to say: Remember a man called John Maynard Keynes? He became what he was by throwing the shibboleths of his Pigouvian ancestors to the dustbin. Remember also a first term US president called Franklin Delano Roosevelt, who said in his inaugural address, “The only thing we have to fear is fear itself”. Sometimes there are great merits in showing imagination, flexibility and speed. Ben Bernanke has shown it. So can you.


Published: Economic Times, September 2008


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