With Inflation above 7 per cent and industrial production growing at 3 per cent, the Indian economy is in trouble. For many years, we envied China’s high growth of GDP and exports and tried to learn from them. Unfortunately, we learned the wrong lessons. This is especially so in the case of China’s management of currency and monetary policy.
We fail to see why some of the policies that can work in China cannot work in India. One, the economic structure is different. China has a large share of investment undertaken by former PSEs whose decisions are not based on market principles. In India private firms make investment decisions in a market economy. Two, the political structure is different. The Chinese Communist Party does not have to depend on political funding or votes to remain in power, unlike a ruling party in India. These differences are crucial in making the Chinese monetary policy model unsuitable for India.
Various commentators have reiterated that policies that work for China should work for India because both countries are poor and have large labour surplus economies. In managing the currency and prices, the Chinese policy of sterilised intervention was described as the perfect recipe for achieving high exports and low inflation. It has been argued that Government only needed to allow the RBI to sterilise and the RBI would be able to keep the rupee weak and exports high. When the Chinese central bank, People’s Bank of China (PBOC), created bonds meant for sterilisation of its currency intervention, massively sold them to Chinese public sector banks and raised the Cash Reserve Ratio (CRR), the RBI followed.
Today, when Chinese inflation has hit 8.5 per cent and the PBOC has raised the CRR to 16.5 per cent, India is still following. Indian policy makers have not woken up to the fact that this is a disaster for India. They completely ignore the fact that public sector enterprises in China can keep investing despite the credit constraints and keep China’s investment rate high, but Indian firms that function in a market economy cannot do so. The higher cost of capital is pinching industry, and can easily push the economy into another 1996-97 kind of recession when the RBI had repeatedly raised the CRR to sterilise its intervention. Policy makers need only to look back at the consequences of monetary policy in India in the 1990s.
