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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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