Thursday, July 03, 2008

The problems of Indian monetary policy

Ila Patnaik continues her series of newspaper columns that shed light on Indian monetary policy: 13 June, 21 June.

Particularly interesting is this piece in today's Indian Express which deals with a question that is on everyone's mind. When RBI decided to use interest rates to combat inflation in the early 1990s, why were such large interest rate hikes required? Why do other central banks achieve the same task with small rate hikes?

1. This comment has been removed by the author.

2. Do you have any insight on why RBI is beholden to exporters, who make a small portion of the economy - a weak rupee doesn't serve anyone else? Surely it's political but why do they have so much influence? Because they are the loudest as group - the bane that we see in other areas of public life?

3. What about the current account deficit? Both you and Patnaik have never really mentioned this potential source of instability, but it makes sense if we try thinking like the RBI.

The RBI seem to assume that a lot of the money coming in is "hot", which is backed up by the fact that our reserves are not so much earned as borrowed. They are borrowed as they come predominantly from capital inflows rather than export earnings.

An appreciation of the Rs would lead to greater imports across the board, blowing out the deficit and making those borrowed reserves look rather vulnerable. Any shock might then precipitate a nasty run.

Your insightful analysis is more often than not based on the assumption of strength, but surely the central bank has to think about the downside risk? Is it paranoid and over-protective? Probably, but given the history, can you blame it?

4. Thanks Ajay, It will definitely be helpful to all of us to get a clear look of what changes are happening recently.
this is the nice information shared with us.

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