The 1,164th open letter to Dr Reddy

Dear Dr Y Venugopal Reddy,

This is probably the 1,164th open letter to you in the short time since you have taken over as the RBI governor, but please don't throw it in the dustbin immediately.

I'm sure you'll find this letter more comprehensive than the other ones, because, you see, I have the great advantage of having read the 1,163 earlier open letters, and have also studied the voluminous and free advice on the economy churned out so generously by economists and editorial writers.

I will start by pointing out that one major headache for the Reserve Bank is the shape of the yield curve. Yes, yes, I know that you will tell me that there are other, better curves to bother about, but I assure you that this is serious. The yield curve, sir, is too flat.

When the inflation rate is at 5.03 per cent, and the ten-year gilt yield is also thereabouts, that's a recipe for disaster. So my first advice is that (a) you need to do something about the lack of curvature in the yield curve.

At the same time, the flat yield line is nothing but the result of all that liquidity sloshing about in the system, and, if and when the liquidity goes it will correct automatically. Bank balance sheets are stronger these days and long-term rates going up a bit won't hurt them.

So my second piece of advice: (b) the RBI needn't bother about the shape of the yield curve at all.

On the other hand, if the RBI does choose to worry about it, what should it do?

That's easy -- the RBI has been proactive in reducing the repo rate to correct the distortion. Only it hasn't gone far enough, and I propose that (c) the RBI cuts the repo rate dramatically in the monetary policy review. That,however, will not be enough.

The RBI has reduced the repo rate several times in the recent past, and yields have stubbornly remained as flat as a chapatti. I propose, therefore (d) that the RBI keeps the repo rate unchanged.

Change inflationary expectations, so that long-term yields go up.

Reducing the Bank Rate is a signal that long-term rates should come down so I recommend that (e) the RBI keeps the Bank Rate unchanged. You see, nobody bothers about the Bank Rate anyway, so it is certainly not a signal about where the RBI wants long-term rates to be. So my next logical suggestion will be to (f) reduce the Bank Rate.

That brings me to interest rates in the banking sector. As we all know, India is a poor country and the low interest rates are taking a terrible toll on widows, orphans (at least those orphans who have fixed deposits with banks) and pensioners.

In my view (g) the RBI should raise interest rates on deposits. We all know, however, that India Inc. is growing stronger thanks to low interest rates and banks should charge even lower interest rates from their borrowers.

I also realise that in order to do this, banks need to lower their deposit rates as well, so I suggest that (h) the RBI should reduce bank deposit rates further.

Then, of course, there's the matter of the appreciating rupee, which is taking such a toll on our exports. I believe (i) The central bank must intervene more aggressively in the forex market to reduce the value of the rupee.

India is critically dependent on oil imports, and higher import prices have the potential to derail the economic recovery.

It is imperative, therefore, that (j) the rupee continues to appreciate. There are also other such immensely vital suggestions, which I have unfortunately forgotten.

I realise, sir, that even with your legendary skills, implementing all these proposals is a tough job. You have three ways out of the problem.

One of them is to have different rates for different market segments -- one rate for orphans, one for fat cats, one for the short-end of the curve and one for the long-end, one rate for exporters, another for importers.

But we are all free marketeers now, and do not want a return to the bad old ways of administrative diktat.

The second option is for you is to pretend these problems don't exist, but you have too much integrity to do that, in spite of having worked for the International Monetary Fund.

Last but not the least, you can leave everything to the market. That will have several advantages. One, you will be immediately canonised by the World Bank. Two, you will be lionised by economists. Three, most importantly, if anything goes wrong and fingers are pointed at you, you can look deeply pained and say, "Who, me? I didn't do a thing. The markets did it."

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