Bond Issuance, Purchases Central Bank – Part III By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

August 30, 2016 | Posted by bobbysrinivasan << back to blog

This is an ongoing conversation between a Student and his Professor.

Student: If the fiscal policy of a country is based on heavy borrowing and big budget deficit, can the citizens of the country raise objections because it is hypothecating the future generation.

Professor: Unfortunately citizens either don’t understand the problem or remain weak not knowing what to do. The same people will insist on fiscal discipline in their house namely living within their means while the country is going to dogs.

Student: Can the monetary authorities stop the fiscal policy makers from creating big budget deficits?

Professor: Unfortunately the monetary authorities are not elected but selected and hence become beholden to the elected authorities. Recently Dr. Subba Rao former RBI Governor wrote a book which touched upon the government intervention in RBI activities. It is a real sad reading. The original intention of the constitution is that RBI should manage the monetary policy of the country and to ensure that the inflation rate is within the manageable level.

Student: I read recently that the finance ministry officials will be involved in the RBI board which fixes the interest rates. Isn’t this a conflict of interest?

Professor: Of course, it is but the claim made by the government is that RBI is not well informed about the overall economy such as unemployment rate, growth rate etc. They think that purely changing the interest rate based upon consumer and whole sale price index may result in policies which will stunt the economic growth. People have no choice and for that matter RBI has no choice but be governed by what the government thinks and wants to do.

Student: This creates a doubt in mind whether RBI is an independent body. What do you think?

Professor: I have no opinion in this regard. What you see is what you get. But being an individual, you can protect yourself by appropriate strategies.

Student: Can elaborate on this?

Professor: Start investing in our Sensex. It has phenomenal potential. Select good companies or mutual funds and stay with them through Systematic Investment Plan (SIP). In the last 5 years they have produced on an average 17 to 20% per annum (see my recent blog on SIP). Put money in gold ETF. All excess monetary policies will result in the rupee weakening and the price of gold will go up. Investments in these vehicles are tax free (read the rules on long term capital gain). You must have seen in the papers as to how the wealth of rich individuals jumped whenever the stock and commodity markets went up. Besides the Indian stock market is the darling of FII’s. They have reaped rich fortunes in the past and will continue to do so.

Student: In your opinion, is the government meddling with the interest rates to meet their election promises?

Professor: Our banks are loaded with very huge NPA’s. So as depositor to the bank you will not get adequate returns which after taxes amounts to negligible as the inflation rate is much higher. Good companies can pass on the cost of inflation to consumers and hence their profits are protected. Look at the performance of software and pharma companies over the last five years. I am certain you will agree with me.

Student: Thanks Professor for enlightening me on this.

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