Wednesday, September 30, 2015

Why Do I Consider Frequent Rate Control Exercise By the Reserve Bank Not Good?

I presume that you have some idea about the basic functions of a central bank in any economy or country. In India it is called the Reserve Bank of India or RBI while in the United States of America it is called the Federal Reserve System and in the United Kingdom it is the Bank of England. There is no standards as to how a central banking organization of a country is to be named and these institutions are known differently in different countries or economic regions.

Essentially, the central bank functions more or less independently and its main function is to control or direct the country's economy properly with various monetary measures or policies adopted from time to time. The central banking system though may be called independent of the government, it is not practically so always. The government does have influence on its functioning, though exercised by indirect means and methods.

The central banking system uses its powers vested on it by appropriate legislation or laws for framing and implementing the monetary policies of the country. Just as individuals deposit money in commercial banks or take loans from them, the central banking system functions as a banking system for the banks. In other words, banks can maintain an account with the central bank and they get an interest for their deposits and they are charged for any loans they take. 

The interest rate at which the central bank lends money to the commercial bank is called the Repo Rate while the interest rate they obtain on their deposits is called the Reverse Repo Rate. The central bank can mandate how much money that the individual banks need to deposit with it at any time. This is called the Cash Reserve Ratio (CRR). Thus the Repo Rate, Reverse Repo Rate and the CRR are often used by the central bank authority for exercising controls on the economy by changing those appropriately. These are like the accelerator, brake and steering of a car!

A car driver can use the pedals and the steering for controlling the speed and direction of the car the way he wants. In a similar way, the head of the central bank ( e.g. the governor of the Reserve Bank of India) can use the control tools for giving direction and speed of the economy.

But a passenger sitting on a car may not feel comfortable when the driver uses his pedals and steering quite abruptly or irrationally or too frequently. We call such a driver a novice who does not know how to drive properly. The car drive could be chaotic and may even prone to accidents. The passengers would be scared for their lives by sitting in such a car. The behavior of such a driver becomes too unpredictable when he happens to drive in a crowded place with narrow roads. His chaotic drive becomes too panicky if he happens to have a master who scolds him too often.

Same applies in the case of the head of the central bank as well. The economy becomes chaotic and unpredictable when such a head cuts rates or enhances rates abruptly or too frequently. The people who happen to be in such an economy become too panicky and confused not knowing what to do next. They may curse the fellow who creates this mess or may even try to jump out of the economy.

When a novice driver starts behaving unprofessionally, there appears many bystanders who cries out various instructions to the driver from the outside for various reasons. Some want to see the fun. Some wants to see and accident taking place. Some may even want to make some money out of the chaos by crooked means.

In a similar way, when an economy starts behaving chaotically under the chaotic policy steps too frequently implemented by the head of its central bank there could be outsiders who start giving directions from outside for their own vested interests. They may be the media, the representatives of business entities, the politicians or even the general public!

When an economy is in an unsteady equilibrium its dynamics becomes unpredictable. In such a situation some people make windfall gains while the majority make huge losses. It is always the uninformed masses that suffer the most. When an insane driver drives the car in a crowded place, it is always the innocent bystanders who get affected adversely!

In short, such a situation takes out the confidence of the people in the economy and the policy makers that drives the economy. More than the certified driving skills, it is the confidence of the passengers that makes a driver more desirable!

And public confidence is the most important thing for a stable and progressive economy. Public confidence comes when the economy is in a steady state of progress that is more or less predictable. Measures taken to control inflation might cause deflation too quickly in an unpredictable economy and frequent happenings of these situation further worsens the situation. Peoples' confidence in monetary policies deteriorates and people begin to bypass the governmental systems in their own manner. And that is not good for any nation!

When an unsteady behavior sets in for an economy, any quick action to set it right could further enhance the instability. That is the general rule for any control system, applicable for the economy as well.

The way the RBI tries to control the Indian economy is causing worries though the media bystanders are extending all praise. ( News-1 / News-2/ News-3

My worries are on account of the following:

1. The Indian stock market cannot ensure safety of savings of the majority public as the Foreign Institutional Investors can suck out public money at periodic intervals of their choice making the uninformed public helplessly watching their savings evaporate suddenly without any notice. Stock market investments are subject to risks and therefore there should be dependable investment options with reasonably good returns such as the bank fixed deposits. The monetary policy makers should not do their acts without addressing this issue.

2. The government has washed its hands from the responsibility of paying pensions to the retired people. Neither the government nor the private organizations now has any guaranteed pension scheme which offers some reasonable income to the retired population. Even the present savings linked pension plans are mere brainwash systems which are too poorly managed causing great sufferings to its members. When pension funds are invested in equities, the same money sucking by the FIIs keep happening which the government nor the RBI can prevent. What the people want is guarantees to their savings!

3. A growing economy in paper with macro economic data do not necessarily safeguard the interests of the individual citizens. When jobs or incomes from employment are proceeding towards the no guarantee mode, how can people take long term loans from banks? If long term loan EMIs to work, it is essential that long term fixed deposits with guaranteed returns also should work simultaneously.

4. Floating point interest system is essentially a cheating system. It is not market driven or based on ethical practices. Once the people understand it well, the confidence in banking system would diminish. It is neither good for the banks nor for its customers in the long run.

5. Unsteady monetary policies help only some individuals to make huge money by way of corruption and it does not ensure good governance.

6. Indian business houses that make huge profits from low interest regime do not pass on the benefits to the general public or even its employees. Neither they do any thing to enhance employment opportunities.

Let me stress this once again. Confidence in the economy and its monetary policies are more important and that cannot happen when the policies change too rapidly and too irrationally without due consideration of ground realities of the nation.

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