Monday, September 23, 2013

Confused RBI Governor, Raghuram Rajan

The new RBI governor, Raghuram Rajan, came with lot of fan fare in his new position as a central banker of this country. People, especially the industry,  had huge hopes from him that he will lower the interest rate and help revive the sagging economy, but he disappointed them by announcing an increase in the repo rate by 25 bps. After his policy announcement many media people are hailing him as an independent central banker who is not getting under the pressure of Indian government. But, is it true? Also, during the session with news reporters, after his policy announcement, Rajan said that his RBI is an "anti-inflation" institution! But, is this also true?

First, the idea of an independent central bank is a joke. The Indian central bank RBI was nationalized in 1949 itself. This quote from the RBI's website will help dispel the myth of autonomous Indian central bank: Though originally privately owned, since nationalisation in 1949, the Reserve Bank is fully owned by the Government of India (see here). RBI is fully owned by the Indian government! How in a world then Raguram Rajan can set monetary policy independently without heeding the needs of his governmental masters? He has increased the repo rate to allegedly fight inflation because inflation is getting out of hand, and the UPA government surely wants to bring it down because they want to capture the huge poor people vote bank. They can afford to anger the wealthy Industry people for a while, but can't afford to alienate their poor people vote bank.

Second, Rajan is flat out wrong when he says, that RBI is, of course, anti-inflation. The irony is, that RBI itself is the sole cause of inflation in the first place. Rajan's confused statements are due to his confused understanding of inflation phenomenon itself. For the mainstream economists like Rajan, inflation is the rise in the general price level, but this definition is wrong because it only focuses on one of the consequences of inflation i.e., rising prices, while neglecting its root cause i.e., increase in the supply of money and credit out of thin air. Whenever RBI prints and creates rupees out of thin air, it creates inflation. It is the root cause of inflation. So to say that it is anti-inflation is a contradiction in terms. If Rajan really wants to stop inflation, then, he should immediately stop creating money out of thin air. Is he doing that? No. Even in his first policy announcement, while waging a war on inflation, he created more inflation by simultaneously lowering the daily CRR to 95% from previous 99%, and lowering the MSF (Marginal Standing Facility) rate by 75 bps to 9.50%. This measures will inject more money in the market, which is nothing but inflation.

What Rajan was doing was running a PR campaign for the government. He is giving lip service to inflation battle, while simultaneously trying (falsely) to look after economic growth by injecting more money in the market. Such balancing act will never work because one guy can not know what the true market rate of interest should be! Trying to play God with the market will always fail. Pinning your hope on one guy will always disappoint whether that guy is Raghuram Rajan in economics or Narendra Modi in politics.

As long as RBI exists, inflation will continue unabated. As long as the State exists, it will continue to exploit us.    

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