Every piece I write on India seems to include the observation that more monetary easing by the Reserve Bank of India is needed. I don’t seem to be alone in thinking this is a good idea for the Indian economy. On February 25th, Arvind Subramanian of the Peterson Institute wrote: “The case for monetary easing is undeniable now not just because growth is declining and inflation is decelerating towards temporary extinction but also because relative calm has been restored to currency markets.” On March 13th, after another small interest rate cut by the RBI (on March 4th), Justin Yifu Lin, the World Bank’s Chief Economist, said “Now, inflation is no more a concern. Deflation is a concern, so I think India can reduce interest rates.” All to the good.
But the Reuters story reporting Lin’s remarks also claimed that “Lin said India should use its $250 billion worth of foreign exchange reserves to finance infrastructure projects.” I assume that is a mistake, and that Lin was not arguing that India use up all its reserves. But should it use any in this way? Subramanian’s piece reminds us that a few years ago, senior policy advisor Montek Ahluwalia had argued for the use of reserves to finance new infrastructure spending. But given how quickly some countries’ reserves have been depleted in recent months, it seems risky to me to be arguing for running down reserves to finance infrastructure. The recent fiscal stimulus announcements had an infrastructure component, and it seemed to me to be structured to be off-budget, but not necessarily using foreign exchange reserves.
Subramanian also reflects on the possibility of monetizing India’s growing fiscal deficit. He argues that with weak private demand and an ineffective monetary transmission mechanism, cutting interest rates may not be enough. Other countries have also been injecting money directly into their economies to cope with the steep downturn, so India would not be a trail blazer in this respect. If I have it right, monetization would also reduce public crowding out of private sector investment. But I cannot imagine the RBI doing this. As it is, they have been so slow to reduce interest rates, that they seem to be following behind the economy’s fall, rather than trying to prevent it. I’d vote for trying to implement some of the Raghuram Rajan committee’s reforms as soon as possible. Improving the efficiency of India’s domestic financial sector ought to help channel domestic savings to productive investment.
Professor of Economics
University of California, Santa Cruz