‘If I Were in MPC, I Would Have Gone for a 50-bps Cut’
Demonetisation was an unfortunate policy intervention. But it contributed in some way in bringing down inflation, says the former chief economic advisor to the finance ministry and the World Bank chief economist, in an interview with
and Basu, who now heads the International Economic Association, was in Mumbai to deliver the Lalit Doshi Memorial Lecture. Edited exerpts:
Is the 25-bps policy rate cut by the Reserve Bank on Wednesday adequate? I am very happy with the rate cut. It had to be done. If I were to vote, I would have voted for a 50-bps cut itself. I can give some reasons. I feel investments need to pick up. For a variety of reasons, the investment to GDP ratio has been on a downward slide for the last seven-eight years. But it’s sharper now. It’s about 28% of GDP from its peak of 38%. Cutting rates tend to make people more free to borrow. Demonetisation caused drying up of liquidity in people’s hands. So, you have got to give that a boost. The fear that inflation could pick up may not happen for the next seven-eight months because the amount of cash in people’s hand has gone short, but it is coming back slowly. So, I don’t expect inflation is going to pick up in a hurry.
Do you think RBI is too rigid in keeping rates where they are? No, RBI has to rightly worry about inflation. I like the idea of a central bank being cautious. But as an independent economist, if I were in that committee casting a vote or advising, I would say cut a bit more because you have got to give growth a big boost and you really don’t have to worry too much about inflation over the next six months.
Do you think it is demonetisation that is driving inflation down? There are a variety of things involved. But there is a bit of a factor that has to do with demonetisation. Agricultural output was fine despite the demonetisation. People were already into the sowing season, they did take care of it. But by the time they were going to buy that output, they were short of cash. Demand for food fell. The food had come into the market that got stalled. In recent weeks, prices of tomato and a couple of other things are going up. But it is item-wise. So, demonetisation did play a role. But I don’t know how much. Has demonetisation really served its purpose? I think demonetisation was an unfortunate policy intervention. There is corruption and I appreciate that the government wanted to do something about it. But how do you tackle corruption? Over here, 86% of the value of the currency is attacked. It is too big a jolt to the market system. I believe markets need regulation and control. But 86% of the market getting a shock is too big. So I think it was an unfortunate move with a good target. If you look at the package of policies like GST, a whole lot of very good moves have happened. But this was an unfortunate one.
The NPA problem is an old one but there is now an effort to clean up the system. What is the real issue and what is the solution to this? NPAs have been going up for the last nine years, but the good thing is that attention has been drawn to it. Usually, NPAs build up but banks ensure that their balance sheets look nice. After Raghuram Rajan took over attention has been drawn which is a great tribute to him. Now that attention is on this issue, we can expect some solution. One of the reasons why NPAs have built up is because of crony lending which has been happening for a long time in India, especially with public sector banks. Hopefully that will now go down which will bring down NPAs, so we are going in the right direction. But as long as you are negotiating a big NPA, there are risks involved like I saw when I was in China where the debt-GDP ratio is large.
The rupee has been rising. How will it impact India when forex reserves are at a high? On the exchange rate front, I don’t see any major concerns. India’s reserves are at the seventh highest in the world. But comparatively, China is at $3 trillion and Japan at $1 trillion, for India to be where it is, is a comfortable position. My view when I was in government was that we should use a small fraction of the reserve very actively and put it for use for things like infrastructure, which could bring long-term returns to India. But RBI’s view was more cautious because it wanted to keep reserves in hand to intervene in the market, which was also understandable. If we use a bit of reserves judiciously for infrastructure, that can give India a boost.