ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

Ashima GoyalSubscribe to Ashima Goyal

Government Securities Market

Over 2017–18, there was a sharp rise in Indian government securities interest rates unrelated to fundamentals. Examining each of the standard explanatory variables shows them to be inadequate to account for the rise in bond yields in this period. Turning to aspects of Indian structure, the reason is found to be the narrow focus of monetary operating procedures, with excessive reliance on making up liquidity shortfalls with short-term liquidity, which was inadequate given large exogenous durable liquidity shocks, including foreign inflows. The composition of liquidity, share of reserve money and its sources all matter. Open market operations have a significant impact on yields. Large foreign debt inflows induce open market operations sales as G-Secs are swapped for foreign securities to sterilise the effect of inflows on the money supply. G-Secs yields are then found to rise.

Overreaction in Indian Monetary Policy

A significant decline in trend growth rate had led to a debate in India that the central bank’s monetary policy in its exuberance for inflation control is stifling growth. Though the rise and fall of inflation in the aftermath of the global financial crisis has closely followed the supply shocks, milder monetary policy tightening is required for moderating the negative effects of these shocks.

Demand-led Growth Slowdown and Inflation Targeting in India

A variety of indicators are presented to show that demand restricted output during the growth slowdown of 2011–17. The macroeconomic structure of the economy is such that a policy-induced demand contraction affects output more than it affects inflation. In this context it is important to evaluate the application of inflation targeting. Flexible inflation targeting was too narrowly and strictly implemented initially, although there are signs of moderation in 2018. Since inflation forecasts were biased upwards, the more effective expectations anchoring channel of inflation targeting was underutilised. The output sacrifice imposed was higher than necessary. Finally, possible mechanisms to ensure inflation targeting is implemented flexibly as required in the Indian context are discussed.

Macroeconomic Policy for an India in Transition

Two types of macroeconomic policies, categorised as Type I and Type II, are developed. A comparison shows why Type II would lead to better growth and infl ation outcomes in the Indian context. Analytical frameworks, data, and fundamentals, all of which are found to support Type II policy, are discussed, showing that India’s recent macroeconomic policy has tended towards that of Type I. This implies that growth and employment creation fall below potential even as the potential itself falls. Ironically, the primary infl ation expectations anchoring the function of infl ation targeting are underutilised.

Abductive Reasoning in Macroeconomics

Macroeconomic analytical frameworks change with events they are unable to explain. The process is closer to abductive reasoning that is based on both events and analysis, unlike induction which is data-based and deduction where analysis dominates. Abduction reasons backwards from the outcome to deduce the framework with which it is compatible. Therefore, it is useful to study how macroeconomic conceptual frameworks evolve after anomalous outcomes such as crises. The post-crisis churning is assessed from this perspective using criteria such as greater generality, systemic feedback, and structural aspects. Abductive reasoning is also used to extract the structure of aggregate demand and supply consistent with the observed negative correlation inflation and growth in India. If prolonged growth slowdowns do not reduce inflation, it suggests underlying aggregate supply is elastic but volatile, so that supply-side issues, not excess demand, are primary inflation drivers. Monetary and fiscal policy need to focus on elements that reduce costs, while avoiding sharp cuts in aggregate demand.

Indian Banking

This paper overviews the issues of non-performing assets held by banks; slowdown in credit growth; corporate debt; absence of modern risk-based approaches to management and regulation; the poor record of banks in transmitting monetary policy impulses; and their contributions to financial inclusion. It attempts to show that reality is more nuanced than the standard perspective that blames public ownership or a failure to modernise for the stresses public sector banks face.

Measuring Indian Growth

The article offers some explanations for the large changes in growth rates in the rebased gross domestic product series, but argues that these do not imply a recovery in the macroeconomic cycle. Changes in estimates of savings and investment also support these conclusions. In addition, firms were under pressure to save costs, and thereby growth of value added increased. This implies that industrial growth was constrained on the demand-side rather than the supply-side, while firms' balance sheets remained healthy.

Psychology, Cyclicality or Social Programmes

Analysing the wage rise for Indian rural unskilled male labourers and its effect on inflation, this study tests theoretical priors derived from concepts of fair wages using a state-level panel, correlation of inflation peaks, and sectoral changes in employment, wages, and productivity. Food price inflation and the fiscal deficit are consistently significant in dynamic panel regressions, with the effect of the first three times larger. More than the spread of employment insurance, overreaction to high food prices raised wages. Productivity increased in agriculture but less than in other sectors. The results support psychological causal factors alongside cyclical ones.

The Exchange Rate and Growth

Devaluing to Prosperity: Misaligned Currencies and Their Growth Consequences by Surjit Bhalla (New Delhi: Oxford University Press), 2013; pp 263 + xviii.

Regulatory Structure for Financial Stability and Development

To understand the appropriate regulatory response to a financial crisis, we start from the basic market failures that justify regulation in financial markets. Regulation that induces better outcomes by creating correct incentives for market participants is the key to reform. A combination of micro- and macro-prudential regulation can moderate pro-cyclicality, information failure and market power. Global prudential standards can push financial firms to choose safe over risky strategies, by removing the moral hazard from bailouts, and assuring firms that competitors will not adopt risky strategies either. Universal application of basic standards can prevent regulatory arbitrage. A pure principles-based regulatory approach may be too flexible, but principle-based rules retain sufficient operational flexibility and universality.

Assessing the Fiscal Capacity of Indian Governments

This article assesses the record of different post-reform governments in meeting their fiscal targets and improving both delivery and finances. A variety of indices are constructed, and consistency checks devised to measure relative performance. No government has achieved its targets, but the Congress Party has had the best record in keeping its promises, and reducing deficits. The effect of the growth dividend on lowering government debt and deficits is established. But the failure of the government finances to improve proportionately with this suggests the need for further improvement in expenditure management.

Avoiding Handicaps: Assessing Global Policy Advice for India

Aaditya Mattoo and Arvind Subramanian ("India and Bretton Woods II", EPW, 8 November 2008) offer useful suggestions for India's stance in global groups such as at the g-20. Subramanian ("Preventing and Responding to the Crisis of 2018", EPW, 10 January 2009) does the same for India's macro-policy responses following the financial crisis. But the arguments of the two sets of proposals are inconsistent. Mattoo and Subramanian want India to support a proposal to give the World Trade Organisation enforcement powers against undervalued exchange rates, but Subramanian wants India to follow self-insurance as China did. The reason for the inconsistency may be the authors' preference for India to follow the United States' interests in international negotiations, but to follow its own interests when domestic policy is involved.

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