It’s the government, not RBI, which will decide when to start tapering | Business Standard Column

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Experts need to look at things that have a bearing on the forthcoming elections, namely, food price inflation and the output gap, especially in the industrial sector, which is important for employment

T C A Srinivasa-Raghavan

Market wallahs are wondering when the RBI will start reducing liquidity, also known as tapering. Their pronouncements remind me of how in the 1950s, when Mao Zedong banned betting in China, the rural Chinese would bet on things like which crow would fly off first from the tree. Or, which hen would lay the first egg of the day.

A favourite Chinese clue was the crow dropping its bomblet. The probability that it would fly off then was high, but the problem lay in seeing which crow had done it.

Thus both risk and uncertainty were present.

Without stretching the analogy too far, this is similar to what’s happening now. All eyes are on the RBI which is itself, like the crows, groping for the correct time to start the winding down.

It’s risk is inflation. It’s uncertainty is growth.

In the end, though, it may not be it’s call at all. It may have to do what it is told to do by the government. This is what it has done throughout its existence since 1935. It has always obeyed orders — disguised as ‘requests’ — ever since it’s first governor was sacked in 1937. For the sake of form he resigned.

So the real challenge is to watch the government as intently as the Chinese farmers watched the crows. And, I for one, would be very pleasantly surprised if it chose an early date to start winding down.

The politics of taper

The reason: there are 17 elections between March 2022 and March 2024. That includes 16 assembly elections and one general election. Moreover, these elections are coming at a time when the BJP is on the defensive. So is it’s star asset, the prime minister.

Hence my belief that the experts in the financial markets are looking at the wrong things. What they need to look at are things that have a bearing on the forthcoming elections, namely, food price inflation and the output gap, especially in the industrial sector, which is important for employment.

The latter is still huge. This means growth must be accelerated, for which interest rates must remain low. It’s as simple as that.

But food inflation is clipping along smartly, no one really knows exactly at what rate. (Ignore the latest figure which was heavily influenced by the (-) 12 per cent in vegetable prices in August).

The high food inflation is actually quite strange because incomes of millions have been decimated or reduced. But despite the aggregate demand curve shifting down, food prices have risen.

Barring edible oils, which we import in massive quantities, there is no obvious reason why food prices are rising.

Output is up. Demand is down. And food prices are rising? It happens only in India.

Politically, therefore, food inflation needs to be brought down between now and January. The all important UP assembly election is in March.

If the past is any indicator, it will opt for the soft option: increase imports to augment supply and maintain low interest rates to allow manufacturing to grow.

Government borrowing

That leaves the all-important question of government borrowing from the RBI. Until now it has been quite conservative. But elections, that too so many, are a different thing altogether. And there are the defence contingencies too, to deal with.

In the end, it will boil down to what the government chooses to spend on: consumption or investment. If it spends on consumption it may be of help electorally, but it will stoke inflation. That’s what happened to the UPA between 2012-14.

The correct answer is to not tackle a political problem with economic tools. But that takes a lot of courage.

We will have to see how Mr Modi fares in this regard.

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