Recent spats thrown by the Government at RBI disguises the current economic situation of India as a political issue. The RBI would not mellow the major rates for the fear that doing so will negatively impact an already fragile economy; the Government will not accept anything less than cheap money to finance its notoriously ambitious political projects.
Obfuscating debate notwithstanding, we must be aware that Indian economy is in a quandary getting out of which is going to be painful. The best we can hope is to escape with minimum punishment. The Prisoner's Dilemma is a canonical example of a game analysed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interests to do so. In this game, collaboration is dominated by betrayal; if a prisoner chooses to stay silent, then the other prisoner gets a better reward by betrayal than by silence. It is interesting to note that instead of betrayal, both would get a better reward if they cooperated.
The ongoing spat between RBI and Government signals lack of cooperation between the two institutions. It is unfortunate that their differences are out in public and verbal duels are being settled through media. The not-so-good picture of Indian economy and its inability to do much (before elections) may be the reason why Government has chosen to take the betrayal route to escape the prisoner's dilemma it has landed itself into. To play its betrayal card, it has chosen to bring RBI in the gambit.
While our expectations from these institutions are common, it may help to understand that both have complimentary roles to play. While the actions of RBI are reactionary, it is the Government that needs to take proactive actions. The role of RBI is to fine-tune crucial parameters of economy to ensure that the system runs efficiently. It may need to raise the rates if the economy becomes hot or if the inflation moves up beyond a certain point. Similarly, it may reduce rates if the economy slows down or if low inflation rates allow the rates to fall. The Government, on the other hand, is responsible to deploy the available resources efficiently to serve the intended economic goals of the country. It certainly has all the rights to allocate resources in the parts of the society it feels appropriate.
The present situation is indeed challenging. Ever since 2009, run up in commodity prices has racked up long-term inflation. As long as it was a global phenomenon and India was clocking a decent growth rate as compared to developed nations, run up in prices did not bother the Government much. On the contrary, it was busy doling out expensive schemes that had no productive contribution on the output of economy. Then came the European crisis in 2010-11, followed by the resurgence of US economy which brought the Dollar back in demand after it had been devalued vis-a-vis other currencies of the world, including the Indian Rupee.
As Dollar appreciated, India's Current Account Deficit (CAD) condition worsened further with the depreciating Rupee. A dwindling currency is not good news because it not only worsens CAD and Fiscal Deficit condition, it also has a potential to give way to hyperinflation if not checked in time. Our fiscal discipline has always been an alarming concern, which was set to deteriorate further with introduction of unproductive schemes such as MNREGA and Food Security Bill. With significant portion of country's earning not adding to the growth in a time when resources are scarce, the result was significant loss of GDP.
RBI faces a Catch-22 situation today. If it increases the rates, it strangles the growth of the economy, as it seems to be happening today. There is no guarantee that growth will rebound if it reduces rates but the move is certainly going to worsen inflation, besides depreciating Rupee, worsening CAD and Fiscal Deficit situation and so on. Caught in a quandary, RBI hopes that the Government will pick the right options from the very limited options left to prevent the ship from hitting the iceberg.
Our economy may not be the only one to face problems, but what distinguishes us from others is our ability to expend energy on non-productive endeavors, including unnecessary arguments we love to play out in public. While betrayal may serve the Government in short term, the punishment the Country will have to endure will be severe. like the two prisoners in Prisoner's Dilemma, who probably know it is in their best interest to cooperate, Government and the RBI seem to have chosen the path of betrayal.
The writer is Director, InvestCare, leading wealth advisors. You can reach him at samar.vijay@investcare.in