Do central banks deserve greater independence? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Do central banks deserve greater independence? 

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In this issue:
» US banks pay out US$ 20 bn
» Is the Euro crisis over?
» Is coal losing its sheen in the developed world?
» Are we in for higher tax rates?
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00:00
 
Should the Reserve Bank of India (RBI) or any other central banks for that matter be given more independence? India's central bank certainly seems to think so. RBI governor Mr Subbarao has called for greater independence for central banks given that their mandate has increased in recent times. Especially since they are expected to play an active role in pursuit of real sector targets such as growth and unemployment. In contrast, noted economist Mr Joseph Stiglitz believes the opposite. For this he has cited the examples of central banks in the US and Europe. Despite the banks in these countries being more independent, it bore the greater brunt of the global financial crisis. And large part of the trouble was on account of the unholy alliance between the central banks and Wall Street. Stiglitz also opines that there is no such thing as complete independence and that ultimately central banks are also accountable for their actions.

Although there is some truth in what Stiglitz believes especially on the accountability front, the scenario is a bit different in India. For starters, the RBI's efforts to have a regulatory check over Indian banks certainly ensured that the Indian banking system was not affected as much as their Western counterparts. Secondly, if the argument is for RBI to have lesser autonomy, then one has to assume that the government is clean and responsible. This has certainly not been the case in India where corruption has tainted every level of the government machinery. What is more, the government has not shown much responsibility in terms of reducing spending and cutting down fiscal deficit. Instead, there has only been more pressure from the Finance Ministry to lower interest rates inorder to spur India's growth.

The crux here is that there has to be an alignment of goals between the Indian government and the RBI. The latter for its part has been taking the responsibility of ensuring that inflation does not get out of hand by sticking to firmer interest rates. But there is only so much that the RBI can do and monetary policies alone cannot solve India's growth problems. Rather than putting pressure on RBI to cut interest rates, the Indian government should take a good, hard look at its finances and display more willingness to do away with its spendthrift ways.

Do you think that central banks such as the RBI should be given more independence like its peers in the developed world? Share your comments with us or post your views on Facebook page / Google+ page

01:36  Chart of the day
 
Notwithstanding the current slowdown, when it came to GDP growth, India has been right up there with its BRIC peers. Especially when the US and Europe were mired in recession. But on many of the other parameters, India has fared quite worse. One such factor has been the current account balance. Indeed, as today's chart of the day shows, India has the worst current account deficit, while countries such as China and Russia have surpluses. This does not bode well for the Indian economy at a time when its spending back home has also shown no signs of abating.

Data Source: The Economist


02:06
 
It's been five years since the subprime mortgage crisis broke out in the US. But the ghosts of the crisis still continue to haunt the American finance industry. In a bid to resolve claims arising from the mortgage crisis, some major US banks have agreed to pay out over US$ 20 bn in two settlements. In one settlement, Bank of America has agreed to pay US$ 11.6 bn to government-controlled mortgage company Fannie Mae. In another settlement, 10 mortgage lenders have agreed to pay over U$ 8.5 bn. This has been done to settle regulators' allegations that these lenders were guilty of abusing the foreclosure system wherein the banks could seize homes from defaulting borrowers.

The compensation for the bad loans is likely to wipe out most of Bank of America's earnings for a second quarter in a row. It must be noted that prior to these two settlements, banks have already paid out billions of dollars as fines and compensation for slack lending standards.

02:47
 
Regulators and policy makers in the West seem to be in a jovial mood! After all, quite a few of them are bringing out their humorous side these days! If the US' proposal to mint a trillion dollar platinum coin has not amused you enough, there is more. The Guardian, UK, has quoted European commission president Jose Manuel Barroso's declaration that the euro has been saved. In fact, he believes that the euro crisis is a thing of the past. Now, we fail to understand what fundamental changes to the Euro zone have brought him to this conclusion.

Cuts to essential public services in Spain, Italy, Greece and Portugal are expected to increase unemployment and lead to further social unrest. Even the OECD chief believes that the 17 member Euro zone could continue contracting into 2014. The only bright spot for the markets was deferment of Basel II norms which allow banks to lend more rather than setting capital aside. Hence, we believe it is too early and too naive for Mr Barroso to make such optimistic comments about the Euro.

03:28
 
You can never be sure about the longevity of a physical resource. This is because technology has a nasty way of reminding us that no resource is perhaps irreplaceable. Take coal for instance. Who would've thought that the commodity that made the industrial revolution possible would be in a state of decline in the rich world? Yet, as The Economist points out, coal's share in energising the whole of US has been falling steadily. At its peak in 1988, coal provided 60% of US' electricity. By the middle of 2012 though, coal fired just 1/3rd of the country's power plants.

Environmental issues aside, the shale gas revolution has also contributed to the coal's downfall. However, experts are not giving up just yet. They reckon that within few years, coal will be back in business. And what will contribute to this rise is expensive gas and the abundance of coal fired power stations, which have a very long life and thus, cannot be phased out easily. In the developing world however, coal will continue to rule the roost. Here, its benefits such as being plentiful and also being cheap will outweigh its major disadvantage of being harmful to the environment.

04:11
 
If the Chairman of Prime Minister's Economic Advisory Council has his way, we may be looking at paying more taxes in 2013. Mr C Rangarajan has proposed a few changes to the existing tax laws. The first is to introduce a tax bracket of 40% to tax the rich at a higher rate. The second is to tax the dividends at the hands of the shareholders. The first one seems to be the fashion of the season with most of the developed countries adopting the practice. The idea is that the super rich should pay higher taxes. It would bring about some sort of income parity and ensure that only the rich pay for the country's progress. The second one has to do with the way dividends are taxed as of now. The companies that declare the dividend pay a dividend tax while the dividend is tax free at the hands of the shareholders.

Both proposals are aimed at increasing the tax revenues for the government. But the important question is what does the government plan to do with this extra revenue? In theory one could argue that this revenue would be used to bring the fiscal deficit under control. However we doubt that this is the path that the government would take. Given the close proximity of the elections in the country, the probability is higher that the government would squander this extra revenue on populist measures. And our hard earned money would be used for buying more votes. What the government needs is a sensible plan for controlling its expenditure. That is what will help bring the fiscal deficit under control. Not by increasing taxes.

04:45
 
In the meanwhile, the Indian equity markets hovered below the dotted line today. At the time of writing, BSE Sensex was down by 27 points (0.1%). FMCG, healthcare and auto stocks were the only exceptions to the long list of losers. Asian stock markets too witnessed selling pressure except Indonesia which was up by 0.1%.

04:56  Today's Investing Mantra
"You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing." - Warren Buffett

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    11 Responses to "Do central banks deserve greater independence?"

    C.K.Agarwal

    Aug 31, 2013

    We need to make our politicians accountable to people every day of the year and not once in 5 years.
    Wrong notion exists in their mind that they have won election so every one else is their servant.
    Let us all put system in place to make our leaders accountable and loyal. As a first step - "NO SECURITY" should be provided to them. This will make them think and choose their action with care.

    Like 

    JIMMY MATHEW

    Jan 9, 2013

    We need interdependent institutions, not independent.

    Like 

    Sthithapragnja

    Jan 9, 2013

    With humility fortified with ignorance of Economics, I may observe as under:
    The RBI is independent/autonomous within the Government!! I am prompted tcite an apt analogy thus:
    The Conductor of an Orchestra 8perhaps unique in the world)does not face the audience but shows his backside only to the audience ??
    Similarly the RBI (rightly so !) is the conductor of most important Orchestra "M"( Vitamain "M" = MONEY)
    For the Orchestra to to create a melodious muscial performance for the audience to hear and cheer , the entire team which may consist of more than 80 or so individual instruments, all have to perform in a clinically synchronised fashion !!

    Similar is the case of the roles envisaged and actual for both the Government and the RBI !Like the two bullocks in a cart yolked together !!Both have to pull forward !!
    I hasten to conclude : with an adage appropriate in this context !! A RAW GOOSEBERRY(AMLA) WHEN CHEWED TASTES BITTER TO THE PERSON BUT WHEN HE IS THIRSTY AND DRINKS WATER,Then and Then only it leaves a sweet taste on the tongue ! Similarly the RBI's Interest rate policy(as many have expressed their bitterness)will be appreciated
    only when a monetary ctastrophe(aas has happened in many developed nations)befalls, will they taste the sweet taste as of an amla ??
    I hasten to conclude !!

    Like 

    parimal shah

    Jan 9, 2013

    Greater the independence (without accountability) to the central bank greater the risk of QE umpteenth number of times. Some sort of accountability and control is needed even on the highest office of the govt (our parliament is supposed to do that - it is another matter that it does not deliver to our satisfaction).

    Like 

    Umesh Sharma

    Jan 8, 2013

    You have rightly stated that RBI cannot ensure growth.RBI can at the most facilitate prompt availability of funds needed for successful implementation of project.But funds alone do not ensure success.There are many other factors and time is one of the most important factors.The Government policies and controlling agencies ensure that the project is dragged along and ultimately the cost overrun will sound the death knell.If we really want to have unchecked growth the Government agencies should be made accountable for speedy implementation of vital projects helping the economy and the nation.They should be strictly deterred from grinding their own axe when promoters approach them.

    Like 

    G. R. Srinivasa

    Jan 8, 2013

    There should be greater independence to the central bank in our country. Had it been like CBI under the government, the country would have gone to dogs long back. There has been greater resistance by our governors in the recent past over governments influence. In fact Sri Chidambaram brought Mr D. Subbarao from the finance ministry thinking he would tow the line. Earlier Dr Reddy did not yield to the finance ministries wishes. Even at that time Sri Chidambaram was the FM. Because of the independence the central bank taking right decisions. This government has never shown any inclination to control either fiscal deficit, dollar's price or the inflation. Populist governing is the motto to be in power.

    Like (2)

    K S Jayanth Kumar

    Jan 8, 2013

    In the Indian context all institutions like RBI should be given complete independence to protect the country's interests because our politicians and bureaucrats are corrupt, incompetent and cannot be trusted to do what is right for the country and our people. Politicians and their cohorts like the bureaucrats will only do what is in their personal interest and what will get them re-elected even if it causes long term damage to the country. Only independent Institutions like the CAG, Supreme Court, Election Commission and RBI have Delivered. On the other hand Politicians have only hurt the country's interest. So there is a strong case to give RBI complete independence given its track record vis-a-vis the Politicians.

    Like (1)

    Madhukar Varma

    Jan 8, 2013

    If I am asked to choose between the RBI Governor and Ministry of Finance (or any ministry of the Govt) my faith will always be with the Governor. There are no hidden agendas here!

    Like (3)

    Venkataraman

    Jan 8, 2013

    You say "due to RBIs efforts to have a regulatory check...." I disagree. It is more likely that RBI had by default controlled every aspect of Banking and the Banking system incidentally has benefited.This is akin to imposing a curfew in town and taking credit for the drop in crime.The real proof of the pudding will be when they free banking in India and then do their monitoring. On the contrary RBI is behind every major scam in the financial sector starting with Harshad Mehta scam,fertilzer l/c scam,NBFC scam of 98, etc etc. The list is endless. Also the conceptual clarity of the Mandarins in RBI in managing macro economics is often in doubt,as in the case of their interest rate management,where no heed is made to address supply side issues. Yet you praise them in article after article.....
    In India the biggest crimes are committed at the policy level.

    Like (3)

    s s manivannan

    Jan 8, 2013

    RBI deserve greater independence. We need not compare with other countries. For India, this is very much required. Otherwise, our politicians will put the country in to severe financial mess.

    Like (2)
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