The sharp stock market correction of April 2nd was in reaction to the RBI’s unexpected attempts towards immediate price stabilisation. Unfortunately, the response to inflation that has been the result of unbalanced sectoral growth in the economy has to be such measures, which would adversely affect the pace of growth and the returns from speculation. However, the RBI has no option but to rein in the rapid growth of liquidity resulting from the sharp increase in foreign capital inflows into the economy, especially the stock markets.

The increase in the overall inflation rate, as well as the rise in prices of particular commodities in the past year, have brought into question both the sustainability of the current economic growth process and the efficacy of public management of price rise in particular sectors.

The image of the RBI as the sober, firm keeper of national interest does not really get reflected in its action. Despite the claim that financial reform has added to the independence of the central bank, its 'Annual Policy Statement 2005-06' clearly shows that the RBI is playing a much more marginalised role in the country's macro-economic management. Its sporadic pro-activeness has also been considerably stifled by political forces.

The RBI's answer to the difficulties it faces in managing the recent surge in capital inflows, which it believes it cannot regulate, is to ease conditions governing capital outflows. The problem with that judgement is that it ignores the relative degree of reversibility of the inflows and outflows involved. While the RBI recognises the fragility of the reserve build-up, the policy direction it is recommending seems to run contrary to such wisdom.

The full implications of the State-directed process of financial engineering in the Indian banking sector, in terms of the changing nature of the institutions, operations and instruments that constitute the sector, would be revealed only in the days to come. But the experience elsewhere provides cause for concern about the increased systemic fragility that comes along with these changes.

Arguing that governments in economies with ever growing forms of new liquidity creation cannot rein in money supply and hence cannot control inflation, the author warns that introducing restrictive domestic credit policies when other economic conditions in India do not warrant such a policy stance, will have depressive effects on the economy.

The Dollar vs. the Chinese Yuan

China is under increasing pressure from the US to revalue the yuan. With the US government unwilling or unable to halt the decline of the dollar, this is seen as the means to prevent a dollar crash that can take the world economy into recession. In this paper C.P. Chandrasekhar and Jayati Ghosh examine the background to this perception and its validity.

Before the finance minister makes conclusive statements about raising the ceiling for foreign investment in domestic banks, it is imperative that RBI and the entire banking community too share a consolidated similar view!

The Dollar Conundrum

The continuing US dollar slid is unfortunately no more the sole concern of the Americas, but could spell a crisis for all unless concerted efforts are set in motion at the earliest, if US is to remain the favoured market and investment destination for all concerned.

The government's expectations that inflation would subside with the revival of the monsoon have been belied. Analysing the factors contributing to the current inflation, C.P. Chandrasekhar and Jayati Ghosh argue that the problem is linked to the context created by liberalisation and is not easily managed within that policy framework.

In spite of RBI’s continuous efforts to cope with the excess foreign exchange in the market, the task of managing the exchange rate is proving increasingly difficult and the rupee is appreciating. Given that the scope for “sterilising” has been exhausted, preventing a capital flow-induced appreciation of the rupee requires targeting portfolio flows.

Internal financial liberalisation has had very adverse effects upon the availability of credit for farmers, adding to the various economic sources of agrarian distress. C.P. Chandrasekhar and Jayati Ghosh consider the main elements of banking reform over the past decade and the implications for agricultural credit in particular.

The euphoria regarding the growth of rural non-farm employment in India is misplaced. More often than not this is a result caused by distress of not being able to find agricultural work. The high number of Own Account Enterprises, which do not hire any labour, is a proof of this. Also, rising income of the rural rich has not led to increased demand for rurally manufactured goods, but for goods typically manufactured in urban centres. The share of the manufacturing sector in non-farm activities in rural India fell from 39 per cent in 1980 to 25 per cent in 1998. Thus, a kind of structural backwardness appears to characterise the development of India's economy.

An important component of the economic reform programme in India was the drive to render the central bank autonomous and provide a greater role for monetary policy designed and implemented by it. In this edition of Macroscan C.P. Chandrasekhar and Jayati Ghosh use evidence yielded by the Reserve Bank of India's just released Annual Report for 1999-2000 to assess progress on this front and examine the role which the central bank and its monetary policy have played in practice.