It is not clear what the RBI officials are smoking, but they do seem to be cloistered in foggy rooms discussing the future course of interest rates and exchange rates. The RBI worries about other policy measures as well e.g. money supply. For more than twenty years now, money supply growth has moved in a narrow range of 15 to 20 percent ; indeed, the volatility in our money supply growth is the least in the world, and least by a significant margin. So this one is truly “untouched by human hands (UTHH)” and one can safely assume that the implementation of money supply growth is not what makes the RBI mandarins smoke.

What does give them a high is the continuing strength of the rupee, a strength they are either comfortable with, unwilling to do anything about, or frozen to do anything about. Unless they are smoking something which is banned, there is little reason for RBI policies to further strengthen the rupee and make us lose competitiveness in this increasingly competitive world - and it is noteworthy that Prime Minister Vajpayee is visiting China at precisely the point where Indian exporters have lost a further precious 5 percent to the Chinese competitors, and all thanks to India's mistaken interest rate and exchange rate policy.

The RBI argues that since inflation is hovering and expected to hover around an annual rate of 5 percent, there is little that it can, or should, do to bring down interest rates. Why would a reduction in interest rates help to relieve upward pressure on the rupee? Because the foreign investors, the true beneficiaries of RBI's misguided and inappropriate interest rate policy, will then find the Indian debt market less attractive. At present, the foreign investor (whether American or Chinese) is finding that investing in government of India administered interest rates is the biggest risk-free gift in the world.

Let me see - one year money is yielding a maximum of 1.5 percent elsewhere, but the richly poor country called India is offering 5.5 percent! So Paul tells Peter and Peter tells Wong and Wong tells Kim about the great Indian sale. Soon anybody with money is flooding into India and buying Indian deposits. This causes the rupee to appreciate so the foreigner does not get 5.5 percent but gets an extra 3 percent in exchange rate appreciation! An 8 percent plus India return - here was a gift to tell your grandchildren, and your banker, about.

But our mandarins are only worried about inflation being too high and like good central bankers, they would like to lower inflation, because they have been told that inflation hurts the poor - so, if you did not know it, our interest rate policy is actually meant to help the poor Indian farmer, especially the one committing suicide because he cannot meet interest payments. Perhaps the RBI should raise interest rates in order to truly and graciously help the (rich foreign) poor get double digit returns. One way for RBI to fast track this development is to take the Labour Minister, the one who argues for ever higher interest rates on provident funds, as its adviser.

Smoke aside, the RBI fire on inflation may be legitimate. In a world which is seriously concerned about deflation, a rate of 5 percent (the present year on year increase in the wholesale price index) is high and something that needs combating. But is inflation really at 5 percent? Policy makers around the world look at inflation after factoring out "volatile" (or relatively trendless) prices of food and energy. However, even manufacturing wholesale prices in India are up close to 4 percent. This is still high and at least partially justifies the RBI's fight-inflation-at-all-costs stand (because, really it is a pro-poor policy).

The conventional non-food non-energy price index is really not that sensible for a poor country like India. Food is a large proportion of our consumption. But energy and other volatile sectors should be factored out. One such exogenously volatile sector is edible oils - it is subject to (nonsensical) taxation, controls etc. as well as weather patterns in Malaysia. This sector has three components - oil seeds (weight of 2.7 percent), oil cakes (1.4 percent) and edible oils (2.8 percent). Thus, this is a small sector (collectively only 7 percent) and its trendless volatility suggests that it is a good candidate for non- inclusion in a core index.

A core WPI, one stripped of fuel and oils, has risen by only 3.5 percent over the past year, compared to a RBI bandied 5 percent rise in the general index. Further, if seasonal adjustments are made, then the latest estimate of core inflation declines by a further 1 percentage point to only 2.5 percent! Which means that those who purchase 1 year Indian bank deposits are getting more than 3 percentage points in real terms, when depositors around the world (including China, Korea, Europe, USA, Timbuktu) are glad to receive a real rate of close to 0 percent. Which means that the RBI is whistling the foreigners tune when it claims that inflation is too high in order for it not to lower interest rates. The RBI has plenty of room (around 300 basis points) to cut rates - for evidence, it should just look at how eager the foreigners are for the obscenely high-yielding, flying high Indian interest rates.

Even if the RBI is mad about its interest rate policy, there are several other instruments it can use to increase competitiveness of Indian firms. If the world is frothing to purchase Indian assets, why doesn't the RBI allow Indian citizens to be mad about foreign assets? Allow Indians to buy real estate in New York and stocks of IBM. At RBI administered exchange rates, these assets will come cheap; no point, having a misguided FX policy unless at least the poor Indians can profit from it. And who knows, demand for foreign assets may actually decrease demand, and therefore the price, of the rupee. But the above policy smacks of capital account convertibility, and the IMF and other experts tell us that that is what got East Asians into a financial crisis. Never was a greater lie told; what got East Asia into the crisis was precisely a mis-guided exchange rate policy - a fixed uncompetitive exchange rate accompanied by higher than world interest rates - sounds familiar?

The Finance Ministry can also do something to help Indian industry - it can cut tariffs and bring them down to at least Bangladesh and Pakistan levels. These three simple policies - decreased interest rates, the outside financial world opened up to Indian citizens, and decreased tariff rates - will go a long way towards increasing Indian competitiveness, helping the Indian growth rate, decreasing poverty, and allowing India, and Indians, to achieve their potential of at least an 8 percent GDP growth. In an increasingly globalized and competitive world, that task will not be easy and will need all the help that the policy makers can provide. Charity, via a sensible interest rate policy, begins at home.