Monetary Policy, Hot Money, and PPI
The PPI as an economic indicator should be given due diligence and incorporated to make a better-informed monetary policy framework. — Alok Singh
The Reserve Bank of India’s (RBI) monetary policy has a job to accelerate economic growth, create employment opportunities, and maintain inflation bandwidth. The convenient tool in the hand of RBI is the interest rate. Economic growth leads to better employment opportunities and inflation control leads to better purchasing power parity (PPP). There are a lot of other factors that determine employment opportunities and PPP. For example, the definition of employment itself is a factor in determining the employment data, and the role of the exchange rate in determining PPP is evergreen in today’s integrated financial world.
So, in a single sentence if we have to understand the motivation of RBI in deciding monetary policy then it seems to be difficult. This led to the force-fitted conclusion that the RBI’s monetary policy is maneuvered by inflation targeting. Further, the RBI or any central bank has to pick among, either the expansionary monetary policy or the contractionary monetary policy.
The expansionary monetary policy aims for economic growth and the easy way is to reduce interest rates. The contractionary monetary policy aims to control inflation and the easy way is to raise interest rates. Again, the repercussions of interest rate are on many financial sources with the sinecure being the availability of money in the system i.e. money supply. Money supply itself has a sequence of definitions that includes M0, M1, M2, M3, MB, MZM, and might be a few more.
The money supply data has inputs like total currency and coins in circulation with the public, commercial banks, the RBI itself, traveler’s cheques, demand deposits, savings deposits, time deposits, and many other spaces of the money market wherever the money flows. It means in simple language that “Expansionary” means increasing the money supply and “Contractionary” means decreasing the money supply. This simplicity is not so simple in real life.
Whatever the monetary policy decision the RBI fixes for a quarter consumes time to cascade. The impact itself has its own lead time to be effective and the time lag is sometimes instantaneous and sometimes multiple weeks. It means that the band of time lag is different for different sectors, few sectors can realize immediate effect while few need lead time of more than fifty weeks, and few might not be impacted at all. The immediate impact is on hot money i.e. the money that are in the space of stock exchanges, whether that be foreign money or indigenous money with foreign money being more volatile. The delayed effective impact is on long-term investments.
The monetary policy of RBI itself is a short-term goal. However, the sequence of short-term goals is as good as a long-term goal if the direction of the goal is not changing in subsequent monetary policy announcements. If the direction is changing in neutralizing the last monetary policy announcement in the current announcement it is very near to a stable monetary policy announcement in the long term. Unfortunately, in the era of fintech, credit cards, e-commerce, crypto-currency, and many other technologies based financial instruments the length of the long term is diminishing. But this technological era has equipped us with strengths as well.
The cheap internet and affordable smart-phones along with the young and aspiring youths of our nation have hedged the impact of FIIs in the stock market, hence also due to changes in monetary policy in our stock exchanges. This happened as our youths who are anywhere in the nation whether it be rural, urban, semi-urban, financially literate, financially illiterate, educated or lesser educated are owing more than sixteen crore demat accounts today. Few of them have multiple demat accounts, and discounting multiple counting, the small and big individual retail investors in our stock markets are approaching ten crores soon. We need them and should create awareness so that the chances of them risking their financial stability are reduced almost completely in the hot money market that includes currency market as well.
The RBI monetary policy should incorporate appropriate weightage to these new small investors in hot money vis a vis FIIs. The definition of inflation is another domain that needs appropriate modification as per the contemporary contribution of various baskets of sectors.
The widely used Consumer Price Index (CPI) captures the price that an end user pays for the goods and services. The Wholesale Price Index (WPI) captures the price data at the level of wholesaler and the WPI is able to capture the data of physical goods only. WPI usually misses the price data of the services sector. The contribution of the services sector to the economy is highest. The Producer Price Index (PPI) is a more balanced approach as it captures the price that a producer of goods and services receives from its consumers. It is the selling price of goods and services over a period of time. We need to create PPI data and the RBI can rely on it for monetary policy decision-making.
The idea should be to come up with monetary policy recommendations based on CPI and PPI both. If there is a significant difference in policy recommendations based on these two sets of data then further brainstorming needs to be done. It is a tough choice to completely replace CPI with WPI. We should work on gathering the PPI data and spend some time with both the data then make a call whether to have one or two or all.
The complex mathematical algorithm has failed to address the concerns of economic growth, employment opportunities, and inflation concerns in black and white. Economics is a beautiful faculty that can’t be pure science or a pure humanities. The fintech has further complicated the landscape of economic policy including that of monetary policy. The PPI as an economic indicator should be given due diligence and incorporated to make a better-informed monetary policy framework.
The role of RBI has to move beyond that of the behavior of a football goalkeeper. The goalkeeper despite knowing that fifty percent of the time the ball comes straight, the goalkeeper leans in one direction, and majority of the time it is in the opposite direction to that of the approaching ball. This happens as the time to make a call is a very small window and it’s not possible to switch the direction midway. We wish good luck to the world’s central bank including our RBI.
(Alok Singh has a doctorate in management from IIM Indore and is currently Delhi based freelancer academician.)
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