SUGGESTION TO THE PMEAC CHAIRMAN DR C. RANGARAJAN

SUGGESTION TO THE PMEAC CHAIRMAN DR C. RANGARAJAN

To: The Prime Minister Economic Advisory Council Chairman Dr. C. Rangarajan

From: Athinarayanan Sanjeevraja

RE: India’s GDP Number

Suggestion:

Good morning sir. I hope that you remembered my last mail dated on June 29, 2011 regarding inflation. Now the Indian economy is suffering as a consequence as I mentioned in my last mail. I accept that high inflation would debase the currency leading to economic destabilization. Hence RBI’s policy of raising interest rates 50 bps on July 26, 2011 to reduce demand and prevent high inflation corrects. I have said so in my previous mail the current approach to monetary policy is fundamentally flawed whether it is based on targeting inflation or the growth in the money supply itself. Monetary policy may have been a strong lever to control the economy in the past but today too much money has ended up in the hands of the wealthy with no place to go. I believe that managing the nominal rate of interest is the most appropriate way of creating a stable economy.

As you knew that there are two rates of interest, one is money rates of interest and another is natural rate of interest. If the money rate is lower than the natural rate, it will become profitable for entrepreneur to invest, encouraging an expansion of supply. The rate of growth will be steady when the natural rate of interest is higher than the money rate, it brings a higher rate of investment given the incremental returns that are available. In other words, it causes a flurry of investment activity as entrepreneurs, individuals and companies chase higher returns. It is this increase in the demand for capital to generate higher profits that starts off a credit boom. The effect of this boom is that future production will be much higher than future consumption which in turn will be less due to lower savings. The only way of resolving this imbalance is to bring the money rate and natural rate back into equilibrium.

In my opinion, by focusing on inflation and money supply, RBI missed the depressing effect on prices. I would like to suggest keep the real interest rate moderate and boost the economic activity by boosting demand until economic activity starts rising due to productivity growth which will happen in the long run. In addition, to increase growth without increasing inflation, production bottlenecks need to be rectified. So that India can achieve at least 8.2% GDP as you projected recently.

Thank you very much for your kind attention Chairman.

Sincerely,

Athinarayanan Sanjeevraja

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