Underlying liberalisation was an intent to have less government interference with greater reliance on market forces.

Are we afraid of the market forces? This is progressively becoming a phenomenon which is witnessed in almost every market where there is interference in some way by an extraneous force that directs prices in a particular direction. While this is not specific to India and witnessed in other countries too, it does appear that we are still not open to the idea of an open economy where market forces determine prices.

Underlying liberalisation was an intent to have less government interference with greater reliance on market forces. Intervention in markets was to be selective, when there was excess volatility caused by either speculative forces or when the repercussions were severe on other segments of the market. However, in the last few years there has been a tendency of excessive intervention in markets by the regulators under advocacy pressures from various interest groups, including the government, which has severed the link between the market forces and prices.

First, let us consider the area of prices. Commodity prices are generally driven by demand-supply forces that are efficient as they allocate resources in an optimal manner. However, in India, there is always a case of looking at prices from the point of view of an interest group. Hence, when farm output is very good and prices come down, the focus is on protecting the interests of the farmers which means offering higher prices through the MSP mechanism. An anomaly results because the MSP is announced for all crops even when there is no procurement scheme in place. This creates a distortion in prices.

The idea to protect the incomes of farmers is laudable, but should be done outside the price system, and this is where the DBT can be used to transfer amounts to the farmer while keeping the price at the market level. This is, however, a challenge because identifying farmers and the quantities sold at the mandi is not easy as not all transactions are recorded in the official books. It is estimated that only between 20-50% of sale of various products gets recorded in the mandi. At times, the person selling may not be the farmer but the arhatiya and, hence, reimbursement in cash is not easy.

A way out would be to rely more on futures prices determined at exchanges like NCDEX that specialises in farm products. Farmers tend to select their crop based on static expectations. If tur gave high prices last year on account of shortages, then more farmers sow tur, leading to surplus production and a fall in price and income. Ideally, the futures prices should be used to choose the crop to be sown; this will also help escape this cobweb syndrome. In fact, the mess in pulses could have been avoided had the tur and urad contracts on NCDEX been restored after being banned over a decade back.

The case of oil and fuel products is also interesting; here, prices have been largely freed. However, there is a high level of distortion with the taxes being almost 100% of cost on petrol and 67% on diesel. Given the high revenue to be earned, the entire price structure has been distorted and severed from developments in the global market. Therefore, when global price of crude crashed from $140 to $40 levels, the price of fuel products did not come down commensurately as the government raked in the additional revenue as tax collections. Here, the government distorts the price through the tax system.

Second, in the forex market, the actions of RBI have been very aggressive and the tendency has been to protect the exporter to a large extent. The central bank has been purchasing dollars in the market in a big way, to ensure that the dollar does not appreciate too fast. In the first 11months of FY18, the purchases amounted to $32.7 billion while the rupee appreciated by 4%. Quite clearly, it would have been more rapid had this intervention not taken place. Similar purchases, of the magnitude of $10.2 billion and $12.3 billion, were made in FY16 and FY17.

Normally, intervention is called for when there is excess volatility due to speculative activity when exporters delay bringing in dollars or importers buy in advance which causes the rupee to fall. In such cases, RBI is justified in supplying dollars. However, the fundamental question is whether the central bank should buy dollars to keep the exports ticking? As all central banks do this, there’s a competitive action of sorts taken to ensure that currencies do not strengthen too much vis-à-vis competing nations. Ideally, central banks should be agnostic to the exchange rate driven by fundamentals as they tend to self-equilibrate. But exporters are given priority compared with importers who gain from appreciation.

Third, the conduct of monetary policy focuses too much on reducing rates, and the tone gets defensive when rates are not lowered. The focus is always on borrowers and growth even though the parameter targeted is inflation. The policy statement seldom talks of the savers who tend to lose when rates are lowered. Ideally, the interest rate should be reflective of the cost of capital. In a capital scarce economy interest rates must factor in the risk factor. Bank loans normally tend to involve lower-rated loans which gain from lower policy rates automatically. The pressure put by the borrowers always works, but has led to adverse selection—visible in the high NPAs today.

Even in the market, the benchmark rates, especially the 10-years GSec bond, have a downward bias, which helps the government. As the benchmark changes every year to correctly reflect the tenure of ten years, the new benchmark normally goes with a yield of at least 20 bps lower than the existing one. As RBI holds the dual responsibility of arriving at the monetary policy and managing public debt apart from being the banker to the government, the focus is naturally on lowering rates. This works well for banks too, which need to value their investments; hence, there is a natural prop to make their books look better as the AFS and HFT segments of the portfolio are valued higher. Here, the interests of the banks are taken care of. It is not surprising that there is never a loud call for raising interest rates by the government, corporates or banks!

It is probably only the stock market where there is no obvious push coming from the regulator to keep the indices in a particular direction. This could be probably because the market is mature and share prices affects investors and not the common man, farmers or corporates. Agnosticism is clearly the call for efficient functioning of markets.