The big RBI ‘U’rjit — turn and why you should not ignore it!

India went through some very tough times over the last decade waging a war on inflation. We all saw our savings dwindle in the face of inflation. FD and PF interest rates struggled to keep pace with inflation and most of us who relied on these instruments for our savings only ended up poorer than we were a decade ago.

Love your Dosa? Then don’t ignore Dosa Economics!

Governor Rajan took charge of the RBI at a time when there were serious scares of hyperinflation and India was at the risk of defaulting on its external obligations. It took well over 4 years of a very tight monetary policy to bring inflation back under control. Parallel to that the RBI also pursed several reform measures. The most important of these measures was the clear definition of the primary objective of monetary policy. It was decided that the RBI’s primary role would be to ensure that inflation stays at 4% +/- 2% (Governor Rajan’s ‘Dosa Economics’). This is very similar to the role that Bank of England (BoE) plays. The BoE’s primary objective is to keep inflation within 2% +/- 1%. The RBI also initiated major banking reforms, and went after crony capitalism. It also made serious efforts towards reforming our capital markets, and took steps that could potentially see Indian bonds being included in global benchmarks for the first time.

The ‘U’rjit-turn

The new man in focus. (Reuters/Danish Siddiqui)

However, under new Governor Patel, the RBI last week signalled a major shift in these policies that went largely unnoticed. While the expectation for inflation one-year down has gone up by 1.8% to 11.4%, the RBI went ahead and cut interest rates. This is counter intuitive. The Governor cited several reasons for this move including — easing of supply constraints, improved infrastructure, ease of doing business and pro-active food management.

While I don’t question the fact that the Government has initiated measures to achieve all of the above stated objectives, there is scant evidence that any of them have actually worked. The RBI’s forward projections do actually take a lot of these factors into consideration indirectly. However, the Governor chose to believe in qualitative assertions of the government and ignored the quantitative data generated by the RBI itself.

So what does this policy shift really mean then?

This is a very clear signal from Governor Patel that the RBI no longer considers keeping inflation within 2–6% its primary objective. This seems to have been replaced by the aim of keeping balance sheets of Indian industry healthy.

The benefactors of this policy shift will be the banks, industries and companies that are reeling under a mountain of bad debt. Core industries like steel, cement and power will reap the immediate benefit as their cost of debt will fall immediately.


Yes, loans for consumers will get cheaper as well. The government hopes that this will result in a revival of the real estate sector, that has been in the dumps for close to a decade now. With credit getting cheaper, the hope is that people will consume more as well. The government and RBI hope that we will buy more houses, make more phone calls, eat out more often and also would be willing to pay more for everything that we consume. This will result in job creation and the people who get jobs will start spending and we’ll all live happily ever after.

This, of course, is only half the story. The real hope is that lower interest rates along with the factors cited by the RBI Governor will result in a significant growth in exports. If all these policies work, cost of producing goods in India will fall and we can take away some of the manufacturing jobs from China, Vietnam and Bangladesh. This increase in exports will help our economy create more jobs and more wealth.

What’s wrong with what the RBI is doing then?

Typically, the onus of growth is on the corporate sector and the government. Fiscal policy and private sector investments are supposed to fuel growth. They are better placed to take on the risks associated with pursuing growth, and will ultimately also enjoy the benefits. We as common people have the opportunity to take on some of this risk, and benefit from the returns by participating in the process through capital markets.

However, this RBI move clearly shows that they have decided to shift some of this risk back to the common man. The RBI is effectively forcing everyone in this country to be a stakeholder in the success or failure of specific government policies and decisions made by private sector companies. This increase in systemic risk puts the whole country at a greater risk.

You might think that taking on some of this systemic risk is good for everyone. You would perhaps be right if you own a lot of property and are well hedged against systemic risks. However, if you belong to the middle class or are poor, in the case that this risk doesn’t pay off, you will suffer huge losses in the purchasing power of your earnings.

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There are also rumours floating around the market that India is considering creating a bad bank to revive the banking sector. This signals abandonment of the RBI policy of going after crony capitalists. Instead, we are now considering bailing out bad banks and bad industrialists, like we did more quietly with bad infrastructure companies through the NHAI over the last 2 years.


I don’t need to remind you of how the middle class and the rich thought the farm loan waiver affected the economy. The bad bank in effect would bail out the richest of the rich in the country. To put things in perspective, the cost of bailing out the few super rich would be twice to thrice the amount it cost us to bailout 50% of our population through the farm loan wavier. This move comes at a time when we have still not fixed our black money loopholes. There is no guarantee that this bailout amount would be invested back in India and won’t be siphoned off to some tax haven.

I am not making a qualitative judgment of bailing out the poor vs bailing out the rich or Modi vs Manmohan. I am only urging you to consider the possibility of such a massive bailout failing to revive growth. The failure of the bad bank gamble of Japan, along with several other factors, has left their economy in a recession for almost 3 decades now. The Japanese failure has some great lessons that we are refusing to learn from.

Sounds like it is pro-rich and anti-poor. Why should the middle class care?

The middle class should care about this the most. While the poor will be the worst hit and will lose the opportunity to climb up the economic ladder, the government will increase minimum wages and subsidies to make an effort to ensure they don’t die of hunger.

The middle class that we are part of typically fuels the consumption economy. We are the ones that buy cars, houses, eat out and shop in every e-commerce sale to keep the economy going. We save far less than we should and have very few real assets. Our financial advisors keep asking us to invest in Mutual Funds, to ensure that we can purchase these real assets in the future. That works well when systemic risks are low and we have the freedom to take on risk to the extent that we are comfortable with. However, with systemic risks on the rise, it becomes a double or nothing bet. In case it turns out to be nothing, we are in deep trouble.

We know all too well now how 15% inflation destroys the middle class. The middle class however, has no protection — we will never be bailed out. Remember how we believed we as the middle classes suffered because of the farm loan waiver? Imagine what would happen if the bailout of the rich goes wrong.

How likely is it that these policies will go wrong?

Most policy moves of this government and the new RBI seem to be based on the hope that Make In India will be a roaring success. However, evidence suggests that this policy for now has not worked. Exports have been falling continuously for the last couple of years even as we become more competitive and ease of doing business in India keeps improving. The rumors about a rupee devaluation only shows how focused the government is on promoting exports. However, while I don’t question the government’s determination to make things work, at the same time, I fail to see any strong indications of success.


The success of this policy depends heavily on external factors — none of which look promising right now. The recent Brexit vote, the US election debates and political revival of the extreme right in Europe all indicate that free trade is not going to be as easy as it was in the past. China managed to grow at over 10% for almost 2 decades, led by exports, because of free trade policies, coupled with a strong 4–5% growth in the western world. The West still remains the largest consumer, and is now expected to grow at an average of 1–2% a year for the next decade.


China understands these risks and is now focused on building out it’s own middle class and increasing domestic demand. However, India somehow seems to ignore these structural shifts in the global economy, and is trying to replicate the old Chinese model. And with the chance that global politics will force a u-turn of free trade quite rapidly, Make In India seems to be headed towards a colossal failure, for no fault of our own.

Read More: #Brexit, #Rexit and India’s future

So what should I do?

Well, in case these new policies don’t work out for India, we will most definitely see inflation make a comeback with a vengeance. It will eat away into our savings. Your FDs and PF will fail to keep pace with inflation and your equity portfolio might not do too well either.

There are however two assets that always protect you against these systematic risks — real estate and gold. I don’t need to tell you that these are two assets that have successfully kept pace with inflation pretty much for all of history.

However, making a real estate investment is tough. You need a lot of money and time. With the Indian real estate sector almost always failing at delivering on time, a bad economy is only going to make that worse. After what we’ve seen over the last decade, would you still want to trust these real estate companies to help you protect yourself? property index:

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Therefore, the prudent way to hedge yourself is to increase your allocation to gold. I’m not trying to say that you should invest only in gold. Continue investing in equity, PF and FDs too, for it is possible that an economic revival might happen and inflation might stay under control. However, at the same time increase your allocation to gold, to hedge against the risk that RBI just transferred to you.

When the systemic risks that the US Fed took on under Alan Greenspan broke the US economy, it was gold and only gold that came to the investor’s rescue. From the start of the crisis in September 2008 to September 2011, when the US economy finally started showing some signs of recovery, gold prices in dollars went up 150% and helped US investors reduce losses. Even between 2005 and 2008, when the bubble was forming in the US, gold gave a 100% return to investors — reflecting that even when everyone seemed to believe that this systemic risk the Fed was playing with was paying off, gold investments were attractive.

I have already increased my allocation to gold by 10% over the last week. I will continue to increase it while RBI chooses to ignore inflation. For the responsibility to protect myself against inflation now rests on me, and not the RBI anymore.

The best and the easiest way to invest in gold is through Gold ETFs. They are safe, cheap, liquid and are always backed by real gold kept in safe vaults.

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— Ravinath Dasika, CFA, Co-Founder, Tavaga.

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