The Congress’ inability to learn from its own past experience defies understanding. Step-by-inexorable step, it is going down precisely the road it took in 1995, and step-by-step it is heading for the same dire outcome. In December 1994, the party lost elections in Andhra Pradesh and Karnataka, and set up two committees to understand why it should have lost in these supposedly safe states. One of them reported that the cause was inflation, which had been high ever since the 1991 foreign exchange crisis, and was being pushed up once more by the boom in the economy. So from May to June 1995, with less than a year left for the next election, the party decided that this had to be brought down at any cost. The belt-tightening that began then killed the investment boom of the previous five years and, with that, industrial growth. From 16 per cent between January and March 1996, it fell to zero in October 2000.
I have been warning readers that an exclusive reliance on monetary policy to contain the boom that has set in will have exactly the same effect. But my warnings have fallen on deaf ears. For politics has stepped in once again. After the Congress’ electoral defeats in Uttarakhand, Punjab and Manipur, the party has begun to look for explanations with the same stupidity that it displayed in 1995.
Once again, it has forced the Congress President, Sonia Gandhi, to pronounce that the culprit is inflation. As a result, bringing down inflation has been abruptly moved to the top of the agenda, and the burden is once again on the monetary policy. What no one has explained to Sonia Gandhi is how using the monetary policy to kill inflation will lead to lower growth rates. When that happens, the Congress will lose its sole selling point with the public so far: in the past three years, growth has made sure that no one who comes into the job market is denied employment. If the recession that I now foresee develops — it will take between 10 to 14 months to reveal itself. By the time, the Congress goes to the next election it will have next to nothing to show for its five years in office — at least nothing that ordinary people understand or care about. Unfortunately, we are so far down this road that it may be next to impossible to turn back.
Reserve Bank of India Governor YV Reddy has been fighting a battle against the Finance Minister to give inflation precedence over growth for the last eight months. On Friday last week, he succeeded. After Sonia Gandhi’s pronouncement, the Finance ministry caved in. So, instead of taking a close look at the recent price and investment trends in the economy, Reddy has pushed up the cash Reserve Ratio (CRR) by half a per cent. This is the third successive increase in the CRR in the past few months. Together they have sucked Rs 43,000 crore out of the base of the financial system.
The result has been predictable. Even before last Friday’s increase, three to five-year deposit rates had crossed the 10 per cent mark — 4.5 per cent higher than they were just six months ago. Long-term lending rates to blue chip infrastructure funds were close to 12 per cent. Fixed housing mortgage rates were 11 per cent or higher, again 3 per cent above where they had been in mid-2006. Earlier last week, a sudden demand for rupees by companies selling dollars made call money rates jump momentarily to 60 per cent. Cursed as I am with a long memory, this was a nightmare revisited.
The impact on real estate is already visible — a 10-15 per cent drop in prices in Mumbai and Gurgaon is on the cards. Infrastructure companies are keeping their fingers crossed that the inflation rate does not drop, for if it does, they will be forced to postpone investments too. It is only a matter of time before industrial investment starts being postponed also. After that the Hicks’ trade cycle will kick in and drag us down to the nadir of October 2000.
Mr Reddy, your last increase in the CRR was definitely a mistake. It is true that the economy had been overheating throughout 2006-07. Credit was increasing 50 per cent faster than deposits; oil prices were skyrocketing throughout the previous year, and a combination of home and export demand was pushing up the prices of key intermediates like steel and cement. You began, correctly in retrospect, to apply the brakes through repo rates as far back as October 2005. But throughout 2006-07, the boom kept developing, and to make matters worse, we found ourselves with a sudden shortage of primary products.
Speculators seem to have caught on to this before the government. After five years of staying at Rs 14,000 crore to Rs 15,000 crore, bank advances against sensitive (agricultural) commodities suddenly shot up by 30 per cent last year. Not surprisingly, the wage price index (WPI) for manufactured products rose by 6.5 per cent and that for primary products by a whopping 17.2 per cent. Hence your first two increases in the CRR. And further tightening of repo rates.
But even if your use of these instruments was justified in January and February, by your own yardstick, it was not justified now. For in the past month, i.e. till march 30, the prices of primary articles declined by 0.7 per cent, and those of manufactured products risen by 0.5 per cent. Even the latter was a result of premeditated increases in the prices of steel and cement that were timed to coincide with the budget.
You should, therefore, have waited for the next quarterly review before deciding whether or not to tighten credit further. You should have, above all, seen that if companies are prepared to sell their dollars to raise cash to complete projects, then they already feel interest rates are too high. But, in a spurt of excess zeal, you have used the hammer of monetary policy to kill an ant that was already halfway to death. Besides, you may end with killing a lot else.