Thank God RBI exists! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Thank God RBI exists! 

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In this issue:
» Political turmoil and high inflation go hand in hand...
» Will govt use gold from public to remedy rupee crisis?
» Is the shale gas revolution mere hype?
» What Netherlands suggests about the recovery in Eurozone...
» ...and more!

Tomorrow Dr Duvvuri Subbarao will serve his last day as the Governor of the Reserve Bank of India.

In a very eloquent and insightful parting speech yesterday, the Governor shared an overview of challenges and lessons learnt during his tenure which commenced just weeks prior to the Lehman Brothers crisis of 2008. These were extremely challenging times for India and the global economy. This period also saw central banks assuming a significantly larger role in responding to the financial crisis.

We would like to share some of the very pertinent remarks he made about India's current economic mess. He believes that it is misleading to blame the sharp collapse of the rupee on US Federal Reserve's QE tapering plans. At the core of all our problems are domestic structural factors. For instance, he points out that India has been running a current account deficit (CAD) that is way above sustainable levels for three consecutive years. And quite likely a fourth time this year. Such high CAD was sustained by the abundance of liquidity in the global financial system. This time could have been used to solve structural issues and bring down CAD. But the government remained complacent and acted as if there wouldn't be any end to the flood of cheap liquidity. It continued with its loose fiscal stance.

Now, when liquidity is fleeing Indian shores the government is totally dumbfounded. Isn't that very reminiscent of the ant and grasshopper story?

Dr Subbarao also quite candidly admitted some of his own mistakes, "With the benefit of hindsight, of course, I must admit in all honesty that the economy would have been better served if our monetary tightening had started sooner and had been faster and stronger."

In our view, the Governor deserves the credit for maintaining the autonomy of the central bank and not succumbing to constant government pressure to cut rates. You will recall that Dr Subbarao and Finance Minister Chidambaram have been at loggerheads on the growth versus inflation debate.

Before concluding his speech, these were his words for Mr Chidambaram, "A final thought on this issue of autonomy and accountability. There has been a lot of media coverage on policy differences between the government and the Reserve Bank. Gerard Schroeder, the former German Chancellor, once said, 'I am often frustrated by the Bundesbank. But thank God, it exists'. I do hope Chidambaram will one day say: I am often frustrated by RBI, so frustrated that I want to go for a walk, even if I have to walk alone. But thank God, the Reserve Bank exists."

We don't know whether Mr Chidambaram will agree. But we really thank God that the RBI exists!

Do you think Subbarao was right in not succumbing to government pressure for cutting interest rates? Please share your comments or post them on our Facebook page / Google+ page

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01:30  Chart of the day
Here's more on India's current account deficit. It must be noted that India's high current account deficit has been one of the chief reasons for the sharp decline of the Indian rupee against the US dollar over the last few months. There has been a reversal of cheap global liquidity from emerging markets after the US Fed's hint of a likely tapering of the QE program. As a result, the rupee has fallen over 20% against the dollar since May 2013.

Today's chart of the day shows that India has the third highest current account deficit in the world in absolute terms. As per IMF data as of April 2013, India's current account deficit stood at US$ 98 bn (-4.9% of GDP). This is significant deterioration since 2007 when India had a deficit of US$ 8 bn and ranked 19 on the list of countries with the highest current account deficit.

Data source: International Monetary Fund, April 2013

In India, the rate of inflation currently is in the region of 9%, give or take a few basis points. At this rate, the prices double every 8 years or so. If you consider this steep enough, how about prices doubling every 15 hours! Yes, that's the highest recorded inflation in history. And as per an article in, it occurred in Hungary in the year 1945. Ordinarily, we can always expect a certain rate of inflation as we live in an era of fiat money where money is printed by most Governments in order to cover their deficits. But what happened in Hungary is an extreme case of the same where societies totally break down. And it usually happens in case of wars or some social uprising we believe.

Unfortunately, one such civil war is taking place right in our midst and is also accompanied by very high levels of inflation. Hyperinflation to be precise. As per the same Atlantic article, the disaster in Syria has seen prices in the country spike up by as much as 290%. And with conflict showing signs of getting worse, an even more severe hyperinflation remains a strong possibility. Consequently, people with all of their wealth invested in paper assets would be the worst off. Yet another reason to have a small percentage of one's assets in gold we reckon. And this is precisely the advice Jim Rogers has also given in view of the escalating crisis in Syria.

India's economic problems may yet again find a solution in its obsession for gold. Any talk of using the central bank's gold to help meet India's international obligations revives memories of the 1991 crisis. The country was then facing an unprecedented balance of payments crisis. India thus flew 67 tonnes of gold to Europe as collateral for a loan to avoid a sovereign debt default.

With 31,000 tonnes of commercially available gold in the country currently, the government is once again looking to monetise it. As per Reuters, the RBI is considering a plan to ask banks to buy back jewellery, bars and coins from the public. The precious metal will then be diverted to gold refiners in an attempt to curb gold imports. And this could take some heat off the plunging rupee. While there are no confirmed reports on the scheme from the RBI yet, we wonder if the solution is foolproof. The government has been cracking down on gold imports for a while now. And shifting focus from the core problems towards gold will not offer any riddance.

Much has been said and written about the shale gas revolution in the US. Riding on the shale gas boom, it was predicted that the US would surpass Saudi Arabia as the energy leader by the end of the decade. However, as some ground realities are sinking in, questions are being raised if all this has just been hype.

The reasons for the scepticism are quite convincing. Unlike normal gas fields that have a stable life of around 20-30 years; shale gas fields face fast depletion and have much shorter lifespan. Forget the extra supplies. Even to maintain gas production, huge costs have to be incurred in refracting the same field. And gas prices in US are too low to support this sort of investment.

Apart from commercial issues, the geological challenges and environmental issues associated with shale gas extraction are reasons why shale is unlikely to be the fuel for the future. So far, the boom has thrived on debt and equity funds. But current economic scenario and rock bottom gas prices are unlikely to motivate companies to let the trend continue. In short, the shale gas bubble is in danger of bursting soon.

A tiny nation like the Netherlands gained prominence in the international arena centuries ago on the basis of its entrepreneurial spirit and strong merchant trade. These are traits inherent in the Dutch even today. What is more, the Dutch are also renowned for being prudent when it comes to spending. So what would explain the fact that the country is mired under the burden of debt and recession? The reason is pretty much the same as elsewhere. The housing market has overheated, private debt has soared and there are many incentives luring buyers to keep up the spending.

Thus, the perception that the Southern European countries are the only ones struggling to keep head above water could very well be wrong. On a much broader note, it only highlights the fact that the Eurozone is far from a meaningful recovery yet. Of course, asset bubbles are not new in the Netherlands. The tulip bubble of 1637 is a classic example of prices running way ahead of fundamentals. The Dutch were able to overcome that crisis. Will it be able to tide over this one? Only time will tell.

In the meanwhile, Indian stock markets have slipped into the red and are trading at day's low. At the time of writing, the benchmark BSE Sensex was down by 44 points (0.23%). Metal and Oil and Gas stocks were the biggest lossers. Most of the Asian stock markets were trading lower led by Japan and Singapore. The European markets opened on a negative note.

04:40  Today's investing mantra
"Only when you combine sound intellect with emotional discipline do you get rational behavior." - Warren Buffett
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33 Responses to "Thank God RBI exists!"

Mandeep Dang

Sep 4, 2013

Yes\Subbarao deserves credit for being independent despite pin pricks by the previous and Present Finance
Minister.Above all he slowly made RBI Policy transparent.Furher he stood his ground despite the noises being made about lowering interest rates.Even Berenake has said that Central Bank Governers have a limited role thru monetary Policy,the onus lies on the government of the Day to Maintain Fiscal Responsibity and improve Economic Environment.



Sep 4, 2013

Very good article. Describes global economic scenario based on principles of economics, which most of the central bankers have forgotten. Thanks D. Subbarao for not being one of them.



Sep 3, 2013

If you appreciate RBI Governor for seeing RBI exists and nation's economy survive,job for which he is paid, why not appreciate Finance Minister, who after all went to execute the given mandate, TO GET UPA A THIRD TENURE, AT ANY COST.



Sep 2, 2013

Dr. Subba Rao is perfectly right. Hope his successor will also prove him right !!



Sep 2, 2013

Our Subba Rao has delivered what is expected from the head of a governing bank,where the political parties are either short sighted or are looking at vote politics in all their acts.

Though like the thought that, now subba raoji is relieved of his duties as the Governor, he should be made the finance minister, worry if history would repeat itself like his ex-colleague the current PM!!



Sep 1, 2013

Let us assume that RBI reduced the rates at the instance of Mr P.Chidambaram, then the inflation being in double digit the following would have happened.
1.The savings in bank deposits would have come down as the savers would be loosing money heavily.
2.They would have opted for Gold as a safe heaven which would not erode the principal amount.
3.So most of the saving would have locked up as idle capital.
4.The import of gold would have devalued the Rupee.
5.CAD should have gone up.Re would have plunged.Import of Oil would have become costly & hence the inflation would still had gone up.
6.The current plunging of Rupee and hence all problems that started with this should have advanced by at least a couple of years.
7.So subbarao’s hind sight is correct.
8.Thank RBI's Subbarao and his team for doing the correct thing.



Sep 1, 2013

Surely Thank God and an Independant RBI Governor !!!!

Otherwise the Political Morons have sold the country !!!



Aug 31, 2013



D.V.Subba Rao

Aug 31, 2013

The need of the hour is Duvvuri Subba Rao as Finance Minister and not Chidambaram. Since Subba Rao is vacating office of RBI Governor, he can be elevated.



Aug 31, 2013

He is absolutely right He minced no words whenever he was to express himself He has always been right in trying to tame inflation Growth doesn't happen just by cutting lending rates Mr.Chidambaram tried to pass the buck on to the RBI for tapering GDP growth Mr.Subbarao sir, without you in these years of global crisis, india would have become another Greece.

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