Apart from intemperance, flawed economics
Subramanian Swamy obviously blew it when, while recommending the prime minister terminate RBI Governor Raghuram Rajan’s services, he said Rajan was ‘mentally not fully Indian’ and pitched for more ‘nationalist-minded experts’ in his place. Apart from it not being obvious what ‘mentally-Indian’ even means, a high-flying BJP MP leading such a charge sends out a horrible signal, though finance minister Arun Jaitley did try to douse the fire. Worse, Swamy lays way too much emphasis on the role of interest rates in stimulating investment and production. At a time when the global economy remains in doldrums, banks and corporate balance sheets in India are hugely stretched and local demand is yet to pick up, only an optimist can believe that, were interest rates to be cut, there would be an immediate pick up in supply and investment. In any case, since just half of the 150 bps rate cuts made by RBI have been passed on by banks, Rajan can’t be held solely responsible. A look at Brazil’s recent history, and the results of trying to grow too fast by, among other steps, slashing interest rates—a recession for two years now—is instructive since no country can grow out of sync from local and global economic conditions.
Swamy has a point when he says using the CPI instead of WPI as a policy indicator is a bad idea, but he ruined his case by overstating it to the extent of talking of a ‘wilful and apparently deliberate attempt by Dr Rajan to wreck the Indian economy’. This newspaper has been at the forefront of the debate against using the CPI alone since, given the large weight for food and the big supply bottlenecks in the country, this was always going to result in a very tight monetary policy. Runaway inflation in pulses over the last 15 months has pushed up inflation by an additional 15%—0.8 ppt in April—even though the weight of pulses in CPI is just 2.4%. What made this worse was inflation-targeting—indeed, had it not been for the stroke of luck with global deflation, the 4% inflation target adopted virtually ties India to high interest rates. The blame for accepting an inflation-targeting policy, however, doesn’t lie just with Rajan, this is something the finance ministry has also been in favour of.
Blaming Rajan’s high-interest policy for NPAs doubling to R3.5 lakh crore in the last two years is especially naive since, as Credit Suisse points out in its House of Debt series, the interest cover of many of the most indebted corporate groups is under one. So, even when the economy picks up, it is unlikely these groups—and many, Credit Suisse says, still find their loans classified as ‘standard’ in the books of banks—will become solvent enough to repay their loans. Which is why, the head of Punjab National Bank said that while growth was picking up in stressed sectors like roads, she wasn’t sure if this would help borrowers get more solvent—while PNB just declared the highest loss in a quarter by any Indian bank, it didn’t indicate the worst was over. If the inflation-targeting policy is finally given up, something good may yet come out of the Swamy episode, though the prime minister must keep in mind the positives of having an RBI Governor with the kind of global reputation Rajan has and the fact that, unlike many of his predecessors, he is doing the most to help clean up bank balance-sheets which are India’s weakest link right now.