Prof Dholakia: the policy rebel within the MPC
The term of the first Monetary Policy Committee (MPC) has ended with the government nominees retiring at the end of their non-renewable and non-shrinkable 4 year term coming to end in September 2020. The Government has nominated Dr Shashanka Bhide, Dr Ashima Goyal and Prof Jayanth Varma as replacements for Dr Ravindra Dholakia, Dr Pami Dua and Dr Chetan Ghate.
Given its current orientation – banking on the lending side at least is largely industry and service focused – it would have been desirable to have an industrial economist or more appropriately an industrialist on the panel. If customer centricity is the prevailing buzzword, it would have been most welcome to have someone who could share with the committee the situation and consequences of policy actions.
Hopefully, Dr Bhide with his unique smell of the soil will bring in the necessary native knowledge to the proceedings. May be there is a case for broad basing the skills without increasing the number.
While the functioning may have been cohesive, whether the content and policy prescriptions were appropriate and optimal has been in doubt. How much the monetary policy framework is a contributor to the current run of economic sluggishness is yet not widely understood but that the date of birth of both coincide should give rise to doubts to the discerning. For on many occasions it seemed largely prescriptive in nature based on some borrowed ideals.
Prof Dholakia mostly appeared like the rebel within. And truth be told his dissensions captured the ground realities better than the official statements often.
Probably he was never comfortable with the concept of monolithic or prescriptive nature of the Dr Urjit Patel Committee’s (UPC) recommendations that has guided our monetary policy making since early 2014. As early as in 2014 he had countered the rationale articulated by the then Governor for setting up UPC. In an article published in Economic and Political Weekly in July 2014 he had concluded as follows:
“It is clear from the discussion that the RBI Governor’s assertion of there being not serious trade off between inflation and growth in the country does not get any support from recent empirical evidence. On the contrary, deliberate disinflation would impose a sizeable immediate cost of loss of output on the system. His second assertion on the direction of causality also does not have any clear supporting evidence…” (Page 168, EPW July 12, 2014. But given the time for publication this must have been written much before the committee finalised its report).
That he found a place in the MPC speaks of the Governor’s and the Government’s encouragement of dissensions for enriching the debate.
For him it is not the ideal but the optimal – one which weighs the costs and benefits of policy actions that counted. As briefly mentioned in 2014, he went to calculate the sacrifices made for every 1% variation from the optimal or natural rate of inflation and the prescriptions of Monetary policy. In an article published (with Mr Kadiyala Sri Vrinchi) by the reputed Journal of Quantitative Economics (April 2016), he proceeded to calculate the sacrifice ratio (the % of output sacrificed in order to obtain one percentage reduction in the inflation rate) based on a fairly long period of 18 years of Indian data. The sacrifice ratio is summarised in the table below:
|Estimates of Sacrifice Ratio (SR)|
|Inflation measure||Short run SR||Long Run SR|
The numbers are not insignificant for an economy stuck with low employment growth and more onerous task of pulling people out of poverty. Especially for anyone aware of the deficiencies involved in calculating any statistics in India, the validity, narrow base, considerable lag and poor quality to enforce an ideal rate of inflation against an actual sacrifice of the above magnitude must seem wasteful. His dissensions should be seen in this light and not intent of adding more heat than light to the debate.
He proceeded to arrive at the optimal rate of inflation for India as 5.4 to 6% while presenting his annual Presidential address to The Indian Econometric Society in January 2020. (it was later published in JQE in September 2020).
Based on the regressions on data between 1996 to 2018/19 he observed, “current targets are fixed for combined (states and centre) fiscal deficit at 6%, for CAD at 2%, and inflation at 4%, for a growth at 8%. These are not internally consistent targets, because with the given targets of FD, CAD and inflation rate, consistent estimate for the long run growth as seen (in the table) is only 5.6%—a shortfall of whopping 2.4% points!!”
His equations conclude that to reach 8% growth India would need 2.5% CAD, and fiscal deficit target of 6.5-7% and inflation of 5.4% to 6%.
Probably it explains his preference often for accommodative stance. One only hopes there is a serious review of the inflation targeting levels as well as the approach in the near future. While the targets appear too low, the approach cannot be divorced from our state and stage of growth, degree of integration, and monetary policy reach.
The current state of sluggishness cannot be validly analysed without removing the huge impact that the specific levels of inflation targets as well as the fiscal glide path given by the FRBM review committee whose recommendations again have been prescribed without calculating the optimal or sustainable levels with the result both have started operating as constraints on our growth.