Losing the plot on inflation

Another credit policy announcement, another reminder of how badly this is being done. As Ila Patnaik says:

On a broader note, the RBI continues to disappoint as usual, in failing to make any progress on improving transparency or communication with the market. A 2 to 4 page concise and clear policy statement that cuts down on excessive detail and focusses on the challanges and difficulties before the RBI, the options it had and the choices it made, would have been very welcome. Instead, what one got was a massive 79 page long winded excessively detailed report that misses the woods for the trees. Now, even after the credit policy announcement, the market is still left guessing and is no wiser about what the RBI wishes to do next.

In its 79 page long policy statement Governor Reddy fails to clearly point out the conflicting objectives on inflation, growth and rupee management and instead, appears to suggest that all these are being effectively dealt with by the RBI. The huge increase in liquidity that has resulted from RBI's interevention in forex markets in its attempt to peg the rupee to a weakening dollar are hidden away in terms like "sizable accretions" to the Reserve Bank's foreign exchange assets. The report does not discuss why the net issuance during the year of MSS bonds of Rs.1,05,691 crore during 2007-08 has proved to be inadequate to contain liquidity growth. It fails to clearly articulate why, instead of more open market operations the RBI has chosen to hike the CRR. While there is a lot of discussion about global liqudity conditions, there is no clarity on the impact it has had on interest differentials with India, on RBI's responses in terms of capital controls, on the effectiveness of capital controls and ECB and PN restrictions. In other words, there is excessive details on things that do not matter, and little clear discussion on those that do. This is consistent with RBI's past policy of not being transparent or giving clear signals to the market to allow their expectations to be shaped. It is consistent with the RBI's belief that monetary policy is effective when the central bank surprises the market.

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For almost five years the RBI appears to be hoping that the problem would go away on its own. That is, the pressure on the rupee to appreciate would go away and RBI would be left to be the monetary policy authority and the banking supervisor in peace. The policy of sterilised intervention that it has followed for more than five years now suggests that it sees capital inflows as a short term phenomenon which are addressed by a short term solution. This policy is now showing cracks but unfortunately this credit policy too was a lost opportunity when this issue could have been addressed transparently and decisively.

I wrote a piece in today's Business Standard on deciphering the bad inflationary spiral that we find ourselves in, and the worse actions that the government is taking in trying to do something about it. This is the price we pay for inaction on monetary policy reform.

Anders Aslund has an article Ukraine's dollar addiction on Project Syndicate. I was quite surprised at how much of this story resonated for us in India. Writing in Indian Express yesterday, Ila Patnaik points out that right from the early 1990s, exchange rate pegging has given bad monetary policy. On that subject, see this.