The US Treasury Secretary Tim Geithner and the US Federal Reserve (Fed) chairman Ben Bernanke visited India last week and their first port of call was the RBI. Ben is arguably the most powerful person in the world as his organizations balance sheet at USD 2.9 trillion is at around 18% of US GDP. The Fed is scheduled to commence USD 40 billion of MBS (Mortgage Backed Securities) purchases every month for an unspecified period, and this QE3 (Quantative Easing) will further increase the size of the Fedâ€™s balance sheet making it even more powerful as an organization.
The RBI governor D. Subbarao would have had a tete a tete with Ben Benrnanke. Two central bankers coming together have many things to talk about and it would have been a private conversation. Assuming one had overheard the conversation and reproduced a part of it it, it would have been as follows.
The initial niceties have been left out due to space constraints.
Subbarao: Ben your QE3 is a big headache for us in India as it takes up inflation expectations and Iâ€™m not able to focus on weakening growth by reducing rates.
Ben: I am not at all sure of the correlation between Fedâ€™s bond purchases and inflation in emerging markets. I personally believe that inflation here in India is due to the subsidies given by your government and this creates artificial demand. In the US oil prices are fully passed on to consumers and there is a healthy demand supply balance leading to lower inflation expectations as consumers cut spending on higher prices. In fact I should be worried about QEâ€™s effect on US inflation but at this moment I am not worried as there is enough slack in labor with unemployment rate at 7.8% to prevent any price rise.
Subbarao: Yes you do have a point and this brings me to the sore point of the economy, the government. You must have heard about all the scams from telecom spectrum scam to the coal mining scams that have surfaced in the last four years. Government is bankrupt but politicians, businessmen and bureaucrats put together have enough personal money to buy a few European countries. The government is fiscally irresponsible and has no commitment to fiscal consolidation, yet it wants me to lower interest rates. What can I do?
Ben: Subbarao, I understand your plight. Politicians across the world are all them same (I hope Tim is not listening to this). In the US businessmen fund election campaigns and then ask for favors from the government. However as far as monetary policy goes I do what I believe is right for the US economy and if that is seen as favoring political and business interests I cannot help it. Personally I do not stand to gain from any actions of the Fed and that is the only thing that helps me keep my job.
Subbarao: I wish I could conduct monetary policy impartially but in India it just cannot be done. Let me give you an example: The governments (Centre and States) are always in need of money and they continuously borrow from the market. RBI manages the governments borrowing program. RBI is also the regulator to the banking system and the government owns most of the banks in India. Banks have to compulsorily buy government bonds (up to 23% of Net Demand and Time Liabilities). In a sense, the government runs a ponzi scheme where it issues bonds to fund its deficits and the bonds are bought by its own entities the banks. At RBI we have to make sure that government borrowing goes through without disruption and we have to make sure that banks balance sheets are not ruined by holding government bonds. Hence we have to focus on containing inflation expectations but then the government is intent on taking up inflation through subsidies, employment programs and of course crony capitalism.
Ben: I am also fighting to keep the Fed off the hands of the government. Post the 2008 bailouts of banks and insurance firms (AIG was especially disgusting) the government is tending to believe that I support Wall Street and as public opinion is always against Wall Street it helps the government to show that the Fed is being reined in. In fact the worst thing that can happen to the US economy is Fed being even partially overseen by the government.
Subbarao: How do you deal with politicians and businessmen?
Ben: Keep them at a distance. You are lucky that you are in Mumbai and the government is in Delhi. It gives you enough excuse to meet them less frequently.
Subbarao: Thatâ€™s one saving grace at least. I guess that others are waiting for us outside and it has been a pleasure talking to you.
Ben: The same goes for me. See you in Jackson Hole next year.