A sick person would go to the blood bank to sell his blood every week. He soon became very weak. The doctor would give him vitamins or glucose, but his health would not improve. That is the situation facing the Reserve Bank today. It has raised the interest rates a tad in the recent monetary policy. This small increase indicates the helplessness of the bank. A bigger increase would have brought inflation under control, but hit growth rates. On the other hand, the reduction of interest rates would have pushed growth, but led to higher inflation.

Prices rise because the Reserve Bank of India prints money and the government borrows that money for meeting its expenditure. Say, there is 10 kg wheat available in the economy and notes worth Rs 100 are in circulation. The price of wheat is Rs 10 per kg. Now the RBI prints Rs 20 and the government borrows these monies and buys out two kg wheat from the market and removes it out of the economy. Now, there is only eight kg wheat remaining in the market, while notes worth Rs 100 are still in circulation as previously. The shopkeepers smell shortage. They increase the price of wheat to Rs 12 per kg. This is how prices have been rising presently.
The RBI is printing and the government is borrowing huge sums of money for meeting its expenditures, such as increased salaries of government servants and for supporting leakage of revenue to preferred individuals. Much of this money is sent out of the country. But the RBI continues to mint notes and there is an increase in money supply, while the goods available are as before. The Reserve Bank’s hands are tied in this situation. The bank can increase the interest rates and reduce the money in circulation. People will borrow less at high rates of interest and money in circulation will reduce. But this will simultaneously increase the price of loans taken by industries for meeting their needs of working capital. The production will reduce and that will lead a reduction in growth rate, along with an increase in prices.
The second problem is the decline in the rate of economic growth. We had reached eight per cent, but are now struggling to even hold on to a rate of five per cent today. The reason is a decline in investment by the government. Say, there is an autorickshaw driver, who earns Rs 1,000 per day. He saves Rs 300 and manages his household expenses with Rs 700. He saves money and buys a taxi. Now he earns Rs 2,000 and saves Rs 600 and consumes Rs 1,400 per day. His consumption has increased from Rs 700 to Rs 1,400 per day because initially he reduced his consumption. This is the natural process of growth—cut current consumption, increase investment and beget increased consumption in the next cycle.
But instead of cutting consumption and increasing investment, our government is borrowing to increase consumption, like paying increased salaries to government servants, and spending on welfare programs like MNREGA, food security and midday meals. This is leading to the economy getting mired in debt. This lack of investment is the primary cause of decline in growth rates. The same borrowing would have a positive impact had the government used the money to invest in ports, highways and research.
The only thing the RBI can do in this situation is to increase the interest rates, so that it will become difficult for the government to borrow-and-consume. But it is doubtful whether even such a measure will deter the government from pursuing this disastrous policy because its eyes are fixed on the coming general elections in 2014. The government’s effort is to use money to buy votes and also somehow manage to hold the economy together until the elections are over. The increase in interest burden will take place in future years only. If the RBI adopts the policy of increasing interest rates, it will adversely impact industry. Production will be reduced and that will lead to an increase in prices. So the RBI is essentially helpless in this situation.
The third problem is that of the Current Account Deficit (CAD). This is the difference between our export earnings and import requirements. Our exports are less and imports are more. There are two ways of meeting this deficit. One way is to allow the rupee to depreciate. A cheaper rupee will make imports costlier. A Washington apple costing $1, will sell in India for Rs 70, instead of Rs 50. On the other side, it will make our exports more competitive. Our imports will decline, exports will rise and the deficit will be gone. This is the policy that Manmohan Singh had adopted as finance minister in 1991.
This time around, he has adopted an altogether different and disastrous policy. He is trying to get the dollars from foreign investment to bridge the deficit. It is like the autorickshaw owner selling a ten per cent stake in his autorickshaw to another person. He can then use this cash to meet his increased daily expenditures. This is what Manmohan Singh is trying to do. Japanese investors bought out Ranbaxy. Dollars came into our economy. This money was used to import Washington apples and French perfumes. But part of the ownership of India passed into foreign hands. Other Indian companies were likewise sold. FDI was merrily coming in—for some time, at least. Then this came to a sudden halt. Foreign investors realised that Indian companies were running at a loss. There are few buyers for them now. It is like the autorickshaw owner offering a 51 per cent partnership. He says the partner can be the master and he will be the servant. But there is no taker because the autorickshaw has not been repaired for a long time and is running at a loss. This is the reason why there has been no inflow of foreign investment despite the government increasing the limits in civil aviation, multi-brand retail and insurance. The RBI can do precious little in this situation. It can sell its forex reserves to hold the value of the rupee for some time. But these reserves will not last long.
The basic problems of the economy are bleeding of government revenues via leakage and corruption; increased consumption by government servants and spending for buying of votes; and using foreign investments to meet consumption needs. The RBI is helpless. Inflation will be controlled, but economic growth will suffer if it increases interest rates. On the other hand, growth will be helped, but inflation will increase if it lowers interest rates. The RBI is trying to find a middle course between these twin problems. This is like a doctor trying to find a middle treatment for a patient suffering from diabetes, asthma and typhoid at the same time. The solution to these multiple problems lies in the hands of the government; not the RBI.

Bharat Jhunjhunwala

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