Perhaps the only positive outcome of the recent turbulence at the State Bank is initiation of serious debate regarding central bank autonomy and the monetary policy best suited for our present low growth, high inflation environment. Already the public and media are engaged in serious dialogue about the sensitivity of central bank policy options in such circumstances.
The most important matter to address is, quite rightly, the bank’s independence. While monetary policy concerns cannot completely be divorced from the finance ministry’s framework, the interest rate regime must remain the central bank’s prerogative, ensuring the two complement each other.
Presently, with huge government borrowing, that too to finance largely non-development expenditure, the main purpose of the high interest rates has been defeated. As a result not only has the cost of money increased exponentially for the crowded out private sector, but inflation remains very high, discouraging spending and investment.
As things stand now, monetary policy options are severely restricted. The circular debt issue, rising oil prices in the international market, increasing non-development expenditure and mounting defence and security concerns have cramped the government’s spending ability. At the same time, its debt monetisation has all but ruled out private sector investment at a time when it is desperately needed to stimulate employment and growth.
In such situations, monetary and fiscal policies must work alongside each other. The finance ministry must compensate for the tight monetary compulsion by initiating targeted, expansionary fiscal policy aimed at infrastructure development. These bursts of investment provide jobs in the near to medium term, encouraging consumerism and further investment. But it is important to target the right sectors.
The agriculture sector, being the largest bread winner, must take priority. It has ample scope for reinvestment aimed at enhancing yields. Focused action can not only help check the rural-urban shift at a time when the economy is unable to absorb the rising number, but also produce increased export earnings, further easing pressure on the government. The SME sector must also get more support. With a little patronage in terms of financing, marketting and guidance, this sector has the potential to address the employment phenomenon in a very strong manner.
It is important to note that our limited energy resources make the fine balancing of fiscal and monetary stimuli extremely difficult. We must utilise resources in a way that maximises benefits to our economy. As such, precious resources must be directed towards sectors and industry that utilise our own natural endowments and raw materials, providing two-fold benefits.
Much of the growth of the last decade owed to investment in import intensive industry. While it served its purpose at the time, the policy was exposed as weak and too dependent on global trade flows, some of which were dramatically altered in the wake of the international recession. Therefore, policy this time around should exploit our own comparative advantage and boost our market for raw materials.
The central bank, too, must immediately reassert its autonomy. Compromising the central bank’s independence has profound consequences, both domestically and internationally. It now bears the responsibility of sending signals to the private sector, that their participation in reviving growth will be facilitated, and protected, by relevant monetary authorities.
The bank must now initiate an interest rate cut, no matter how miniscule, to indicate policy direction of attracting investment initiatives. Even a half-point rate cut will suffice for the moment. Presently, the rate is too high, and still unable to contain inflation. These high prices are not due to demand side pressure, but result from unnecessary distortions in the economy. Once the cost of money is reduced, increased investment and employment will bolster consumer confidence, removing some of these price irregularities automatically.
A lot of hard work and foresight went into the decision to make the state bank autonomous in the late ’90s. Unfortunately, government excess, especially increasing borrowing, has compromised more than a decade of monetary stability. Relevant authorities must take this issue up very seriously with the government. A weak central bank will simply be unable to help guide the economy out of the current crisis.
The writer is a former finance minister
