Market capitalisation is around $1.5 trillion (that market cap/GDP ratio of 150 per cent should make one a trifle uncomfortable). India may well have overtaken Taiwan and become the 4th largest holder of foreign exchange reserves. Let’s wait till November 30 for second quarter figures. But so far there are no signs that 9 per cent-plus growth is unsustainable. Manufacturing isn’t in the doldrums it used to be. In the first quarter of 2007-08 it grew by 11.9 per cent and in August 2007 figures on index of industrial production (IIP), manufacturing posted 10.4 per cent. The India Shining story is for real and one can supplement these statistics with figures on telecom penetration or Pradhan Mantri Gram Sadak Yojana.

Okay, reality check: is the world’s poorest individual an Indian? After the 61st round of NSS (National Sample Survey) for 2004-05 became available, it is impossible to argue that poverty hasn’t declined, though there are inter-regional variations. It is also impossible to argue employment hasn’t increased. Critics of reforms used to earlier talk about jobless growth, preferring growth-less jobs instead. Now they talk about quality of employment.

A day before the mid-term review, RBI’s take on this embarrassment of riches was: high real GDP growth; manufacturing doing well for April-August 2007, but some slowdown; services doing well; barring electricity, infrastructure not doing that well; tax revenue buoyant; inflation under control because of “pre-emptive monetary measures since mid-2004 accompanied by fiscal and supply-side measures”; crude oil prices up to $89.5 a barrel; slowdown in growth of merchandise exports, but large net invisibles surplus and large FDI ($6.6 billion from April to July) and FII ($21.2 billion from April to October 19, 2007) inflows. One can’t disagree with this, except on inflation.

We have inflation rates of 3.07 per cent via the wholesale price index (WPI), week ending October 13; 7.26 per cent via the consumer price index (CPI) for industrial workers, August; 7.89 per cent via the CPI for agricultural labourers, September; 7.61 per cent via CPI for rural labourers, September; and 5.7 per cent via CPI for urban non-manual employees, September. As a statistical point, these trends vary because baskets and weights differ, as do points of collecting price data. Having said that, it is impossible to argue that ‘pre-emptive monetary policy’ has had much to do with reducing WPI-based inflation, or can have much to do with reducing CPI-based inflation. RBI has of course hedged by bunging in ‘fiscal and supply-side measures’, which can cover everything else under the sun.

I haven’t been able to track down who first used the expression ‘pre-emptive’ in a monetary policy context. Pre-emptive action means action taken as a preventive or deterrent measure, often in a war context. I wonder how many people in RBI play bridge, because in that context, a pre-emptive bid has a specific nuance. It is a bid when one has very few high card points and wants to disrupt communication between opponents. RBI has almost no high card points in determining monetary policy.

We shouldn’t forget the Foreign Exchange Regulation Act (FERA) yet. The second half of the Preamble to FERA (1973) said this was legislation “for the conservation of the foreign exchange resources of the country and the proper utilisation thereof in the interest of the economic development of the country”. Given our foreign exchange reserves, all that has changed is that instead of conserving foreign exchange resources, the central bank now conserves the exchange rate. If an economy does well, as India’s is, one can’t prevent currency appreciation.

Moses kept telling the Pharaoh “let my people go” and when the Pharaoh didn’t listen, Egypt was visited with ten plagues. Not letting the rupee go is not without its plagues. Not only have economies done well when currency appreciates, the Chinese example notwithstanding, it is impossible to maintain under-valuation when capital flows aren’t restricted. RBI highlights rupee appreciation against US dollar, euro, pound and yen, especially the first. What is important is not just these currencies, but others too, and the real exchange rate, not the nominal one. Once one does that, depending on the index used, evidence on rupee appreciation is much more suspect.

But we will not allow the exchange rate to be completely determined in the market and will mess around with market forces. Apart from everything else, exporters and the commerce ministry will scream blue murder and we also have this notion about separating speculation-driven volatility from secular trends. So fix some arbitrary rupee/ dollar rate, perhaps allowing for appreciation of 10 paise a month or something like that and buy up dollars to preserve that reference rate.

Other than the sub-optimal (excessive) reserve problem, this fuels liquidity. Hence the need for hardening rates and mopping up liquidity through CRR increases, since sterilisation doesn’t work. To justify this, one may as well invoke the inflation spectre by citing high CPI-based inflation and the unlikely eventuality of higher domestic petroleum prices materialising, particularly because earlier interest rate hikes don’t seem to have hurt industry (or investments) that much. However, goods exports have been hit by rupee appreciation. This is the background to the half-yearly review of monetary policy.

In all fairness, no one expected RBI to slash rates (bank, repo, reverse repo) yet. However, was there a need to hike CRR to 7.5 per cent? When the UPA government took over, CRR was 4.5 per cent. Indirectly, CRR hikes prevent commercial banks from reducing lending rates.

Since 1991, RBI has been adroit at managing forex shortages and crises. However, RBI’s monetary policy still hasn’t figured out how to manage foreign exchange surpluses. To compound the problem, other central banks have slashed policy rates (some have increased them too). But linked as we are to the dollar and the US economy, what happens if Federal Reserve cuts rates further? The capital inflow conundrum will worsen. And RBI’s monetary policy will continue to remain a square peg in a round hole.

The writer is noted economist