Monday 11 January 2010

Don't cry for me Argentina

Don’t cry for me Argentina, could very well be refrain of Martin Redrado, the governor of the central bank of Argentina. He was dismissed by the President Cristina Fernandez a couple of days back, only for the courts to reinstate him and rule the President’s action unconstitutional.

At heart is the issue of the independence of the Central Bank. In many countries, including Argentina, the Central Bank is supposed to be independent of the government. This enables it to follow the right, and long term, stable monetary policy without political interference. Governments don’t like it as they like central banks to do what they want them to do.

The problem in Argentina is that Cristina Fernandez would like to use the reserves of the central bank to pay down the debt of the government. The central bank is refusing to do this. So she thought she could sack the governor and replace him with somebody more pliable. Its rebounded on her because of the court’s decision.

The problem is always the tension between fiscal irresponsibility of governments and the refusal of the central bank to support such profligacy. If you spend more than you can afford, you are bound to get into trouble. Its amazing how politicians (and economists) fail to grasp this simple truth - you cannot spend what you do not have.

Argentina’s position is a little special. It actually used to run a budget surplus, but its old sins of too much debt in the past has been the problem. It defaulted on a debt obligation in 2002 and hence is mostly shut out of credit markets. The surplus fell like a stone as commodity prices fell and the recession bit. Populist spending by the Fernandez government accentuated the problem and led to this crisis.

There are some lessons for both India and China. In both these countries the central bank is not independent. In China, such an independence is unthinkable of course. But it is conceivable that an independent bank would not have permitted the massive amount of bank lending that has taken place last year leading to huge bubbles in the property and the stock markets. In India, independence is possible and it would be good for the country to make the Reserve Bank of India independent. That way, neither the netas nor the babus can indulge in the irresponsible actions that they are known for. Its only the presence of 4 or 5 people in the Central government with an enormous sense of responsibility for the nation that disasters have been prevented in the past (remember the early 90s ?).

Monetary policy needs some understanding of economics. India has been blessed with some experts in economics in the government. But if you poll the 545 members of the Lok Sabha and ask them to spell the word economics (in any language), I am absolutely sure that more than two thirds will fail abysmally. Is monetary policy to be in the hands of the ignorant ? No way. Before we reach a disaster, make the RBI independent.

15 comments:

Half Indian said...

one of the unique pieces. Love it!

gils said...

one nimit..naan football pathina postu..maradonangara worday kaanumaynu theditrunthen!! :) intha blogku indigoite ku badila..know ur eco nu title vachirukalam :) semma brainy posts

sri said...

Thats so well said, u cannot spend what u dont have. It goes for all those credit card spenders I know too..

I wish u would be in power to make such decisions to save the country from illitrate hands. I really wish!

Ramesh said...

@Dave - Thanks Dave

@gils - you are too much. The gems you come up with .... Thanks for the kind words.

@Sri - Very true for credit card borrowers as well. You give me too much credit.

kiwibloke said...

"If you ask two thirds to spell economics" loved it! Matter of fact if you ask two thirds to spell (any thing for that matter), they would have failed. We live in a country of pathetic standards where an ex prime minister calls a current chief minister B@5#@^d in a public meeting. If I were to use Gils' language: Thalaiezhuthu!

Unknown said...

Bang on the head of the nail. I like how you put it that 2/3rd of our politicians cant spell economics right... :)

I am currently reading a book called Ascent of Money which says that the cause of this financial doom and gloom can also be attributed to poor financial knowledge of people. for e.g. in 2006 British Financial Services Authority carried out a review of financial literacy to find out that: 1 in 10 people dong know which was better discount on a television worth £ 250 - 10% or £ 30.
I am sure some of these above are also making policies... unfortunately this impacts every one in their country and with globalisation every one in the world...

Deepa said...

I still do have an optimistic faith when it comes to RBI in India. Haven't really heard of RBI Governors playing stooges to the government so far; but maybe I am plain ignorant on this. On the other hand, yes, country's economy placed in irresponsible hands is a scary thought.

But when you say 'independant RBI', do you mean as independant as the judiciary function? Wouldn't that be a bit too liberal too?

Ramesh said...

@kiwi - Gils is perfectly expressive, isn't he ?

@mahesh - Not surprised at your example at all. Its OK with the common man, but if cabinet or parliament were stocked with such worthies then the only way is to stop them from having the powers to screw up the finances.

@Deepa - Yes, I mean like the judiciary. Monetary policy is too dangerous to be played around with. To me the old Bundesbank model in Germany was the perfect example. The Bundesbank listened to nobody and single mindedly guarded against inflation. That's why its so much respected even today long fater it was overtaken by the Euro.

VA said...

I just kind of love it when you talk of our netas and babus. It is really shameful for our democracy to have such ignorant flock of people sitting in the parliament. But as you say "we deserve what we elect"

Even if our MPs do know abc of economics, it would still be bettew to make RBI independent for sense of responsibility is not so common after all.

Sandhya Sriram said...

whether by proper planning, or by sheer luck all finance minsters this country has had have been people who knew economics beyond its spelling.

to that extent, the interventions have if only helped. But agree with you, this will only help in a long term perspective to keep it out of these netas and babus

Deepa said...

I googled 'Bundesbank'. :) And I can see your point now. I went through the profiles of many RBI Directors (starting from the latest ones), they are a very highly qualified and knowledgable lot. They have controlled the valve efficiently so far, but like you said, it definitely is in tandem with what the current government's fiscal policy is.

On Sandhya's point- I feel, all Indian govts so far have been very careful about two portfolios, Finance and Foreign Affairs. And I feel that has been much deliberately done. You can't get away with goof ups in these two places. But yes, we had one Mr. Deve Gowda as PM once upon a time. And fortifying RBI against a calamity like that in the FM does make sense.

J said...

Central bank independence is a very interesting issue and it has to be in shades of gray. Can you truly have independence? Should politicians have no say on monetary policy while they are expected to drive economic policy? When it comes to the caliber of Indian politicians today, I have no hesitation that the more they stay out of everything, the better we are. But assuming we had capable politicians, to what extent should the central bank be independent? I think an independent Central Bank serves the role of checks and balances on the government. But in practice it is all murky. There is an outcry in the US against Ben Bernanke of the Fed and some want the government to audit the Fed. While I dont endorse the government audit, is the Fed above criticism because it is run by a group of smart economists without direct political ambitions. Sorry for rambling...this is interesting stuff but so complicated.

Ramesh said...

@VA - Its rather strange that being a minister, which is one of the most demanding jobs in the world, requires no qualifications. People make a virtue of their ignorance and claim to be a "common man" to get elected. Something very wrong, isn't it ?

@Deepa - Yes RBI governors have traditionally been men of very high stature and so have been Finance Ministers. But we have had disasters like Charan Singh. Before the liberalisation in the early 90s, we have had many poor Finance Ministers. And some very awful Babus. Quite a few political decisions even now (eg repeated loan write offs) have been disastrous ones, which an independent RBI would at least have refused to finance.

@J - You cannot have complete independence of course. But having set a series of monetary policy objectives (eg curbing inflation) in its charter the Central Bank should be left alone, I believe. Independence does not necessarily mean conflict. Governments and the Central Bank can certainly coordinate economic policy, but the governments want to do stupid thinks, the RBI must have the abiklity to tell them to go get stuffed. I know the Fed's behaviour on interest rates during the Greenspan era has led to some controversy, but it is far better to have that than what China is doing today.

VA said...

Yes, something which is totally wrong and disheartening... Have been wondering on this particular stuff since my school days when I studied social sciences. Why there can't be some minimum criterias for filing nomination of parliament elections?

Ramesh said...

@VA - Completely agreee. There must be minimum qualifications for a MP (and not number of murders committed !)

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