Whose monetary policy?

Indian Express, 5th August 2013

It should be left to an independent central bank with a clear brief and instruments

Indian monetary policy law, like that of many advanced and most emerging economies, needs to define the objectives of monetary policy. The sudden shift away from inflation and growth to a defence of the rupee has caused a lot of confusion. In addition, the law needs to lay down the instruments of monetary policy. This could be the repo rate or any other chosen rate. Once this is done, the RBI needs to be made accountable and given independence in order to achieve these objectives.

Today, even if the government achieves Rs 60 to the US dollar, the cost of defending the rupee is too high. Beyond the tangle that the RBI is now in, these events point to the larger question of monetary policymaking in India. Decisionmaking on monetary policy in India will become increasingly difficult in the next two years. The US Fed will stop easing and US interest rates will rise. If the RBI leaves interest rates in India unchanged, Indian assets will become relatively unattractive. This will put pressure on the rupee to depreciate. If the RBI increases interest rates to prevent this from happening, growth in India will suffer. If it lowers rates, there could be additional pressure on the rupee. There may be episodes of high exchange-rate volatility, such as when the Fed announces the date of reducing its purchase of treasury bills, buys less bonds, stops them altogether, or when it starts reducing the size of its balance sheet.

It is well understood by now that once the capital account is open, a country has to choose between pegging the exchange rate and pursuing an independent monetary policy. The impossible trinity tells us that with an open capital account you cannot have both a pegged exchange rate and monetary policy independence. If the business cycles of the Indian economy were perfectly aligned with those of the US, there would be no problem. But if the US is going to raise rates, we have to make a choice: let the rupee be flexible or peg the rupee to the dollar and tighten along with the US. The middle paths that we try to follow are fundamentally problematic and may only have some limited, short-term impact. Meddling with the exchange rate can only be done by distorting monetary policy, and anyone who says otherwise is trying to obfuscate matters.

As the experience of the last couple of weeks shows us, decisions about monetary policy are not straightforward. First, there is no answer to what the correct level of the currency or interest rate should be. Countries witness deviations of the real effective exchange rate from the historical neutral level. This could be because the real effective exchange rate is not always the market equilibrium, as financial markets are influenced by many forces, or it could be that fundamentals, such as changes in productivity, are pushing it to a new value. Whatever the case may be, manipulating the real effective exchange rate to keep it constant or at the correct level, after accounting for productivity changes, at all times, is an impossible task.

Second, whether a currency should strengthen or weaken to stabilise the economy depends on what phase of the business cycle the country is in. When the economy is slowing down, a weaker rupee will help it recover, when it is overheating, a stronger rupee will help prevent inflation from rising.

Third, any policy action will have an effect not just on the currency but also on interest rates, growth, the fiscal deficit, the current account deficit, business sentiment and investment. There are costs and benefits. Both need to be considered.

These issues suggest that monetary policy actions should be made after thorough analysis, discussion and considering different points of view. Knee-jerk reactions that focus only on one element of the impact of those policy changes are bound to be troublesome. Since governments often come under political pressure to do something, if the job of making monetary policy can be influenced by the government, it results in macro-economic mismanagement. It was an understanding of these difficulties in monetary policymaking, after many episodes of painful mismanagement that led to years of inflation, recession, stagflation and largescale unemployment, that led advanced economies to hand over the task to central banks. They were given independence from the government and required to have structures such as monetary policy committees, which allowed informed decisions and a diversity of views.

Why do governments prefer such arrangements? Why do they allow central banks to be independent and pursue policies that are so important for the whole economy? One reason is the shift in responsibility, particularly for all the costs. Remember that there will always be some losers and some winners from any policy decision. In other words, there will always be voices that say that a decision was wrong and point to the losses it creates. Once the public accepts that it is the central bank that makes these decisions, the impact of criticism of the government for inflation or for depreciation or appreciation is limited.

With the Indian economy opening up in the last two decades, the difficulties of monetary policymaking have increased. By now, there have been many government committees which have suggested that it is time for India to move to a modern framework for monetary policymaking. India needs a central bank with independence and accountability, and with a professional monetary policy committee that decides monetary policy actions using well-defined instruments of policy. The latest of such recommendations is by the Financial Sector Legislative Reforms Commission, which has also proposed a draft law. While it may be very tempting for the government to be able to shape monetary policy at a particular point of time, it needs to understand that it will be well served by such a framework.

Does India need sovereign bonds?

Financial Express, 24th July 2013

RBI's defence of the rupee and statements of govt officials suggest the rupee has become too weak. instead of deluding themselves, policymakers might do better listening to what the rupee is telling them

In recent months, when government officials suggested that the Indian economy was still strong, most of us thought they were trying to talk up the economy. But RBI's moves to tighten liquidity and raise interest rates this week seem to suggest that the government really believes that economy is strong enough to absorb large shocks like the those meted out by the RBI. A careful cost benefit analysis of the actions of the past few days suggests that they may be making a very costly mistake. Sovereign borrowing would further add to this cost.

First, why has the rupee depreciated? India has a large current account deficit that needs to be financed by capital inflows. Ben Bernanke's statement suggesting that rates in the US may rise over the next few months led capital to fly out of EMs. Currencies that were being held up by capital flows witnessed sudden sharp depreciation. Along with India, other Ems with large CADs such as Brazil, Turkey, Indonesia also witnessed a sharp rise in currency volatility and significant depreciation. India's falling GDP growth, high inflation, poor investment sentiment and high current account deficit were unhealthy fundamentals to begin with. The US Fed provided the trigger.

Second, is depreciation bad for India at this point? It is bad for companies that borrowed overseas tempted by low interest rates. Those who don't have a natural hedge should either not have borrowed, or have hedged their exposure. On inflation, there may be little exchange rate pass through as the pricing power of companies in a low growth environment is limited. On the other hand, depreciation is good for export competitiveness and import substitution. Depreciation in a slowing economy can provide a demand stimulus to the economy. (Among the first signs already visible are tourists preferring domestic locations to foreign holidays.)

Third, even if depreciation is not good for the economy, can it be prevented? For a short while and at a very high cost, yes. Remember the basic principles of the impossible trinity: You cannot have a pegged exchange rate, an open capital account and an independent monetary policy at the same time. So we can give up monetary policy independence to peg the rate. We saw RBI do that with its interest rate defence. It raised rates despite having convinced us that despite the high inflation, the low growth in the economy had led it to lower its inflation forecasts, and the time for easing monetary policy had come.

So, yes, the rupee can be defended and it comes at the cost of raising rates at a time when the economy can least afford it. But with the tightening, the already poor sentiment about the economy, will fall further. RBI has argued that it raised rates not to attract capital inflows, but to kill speculation. So was the rise in interest rates,such as the call money rate going above its corridor to 9%, merely an unwanted and unexpected side effect? If so, it speaks volumes about the competence at RBI. And if not, it suggests that RBI is engaging in doublespeak where it is tightening liquidity that leads to higher rates,while suggesting that it is not tightening monetary policy as the repo rate has not been changed.

Fourth, are there any quick-fixes available? While the rupee may go up, the fundamental problems of the economy that have lowered productivity growth remain unaddressed. In the long run, if productivity growth in an economy is weak, it should be expected that its currency will depreciate. So, even if RBI is able to prevent further rupee depreciation for a while, unless the government addresses issues of infrastructure, land, labour, access to finance and the innumerable hurdles to investment and productivity growth in the economy, the rupee will continue to weaken in the long run.

RBI's defence of the rupee and the statements of various government officials suggest that the rupee has become too weak, that the fundamentals of the Indian economy are stronger than what the currency market is suggesting and the rupee should in fact be stronger. In other words, they believe that the market is wrong in thinking that there are fundamental weaknesses in the Indian economy. Instead of deluding themselves, policy makers might do better listening to what the rupee is telling them.

The taming of the rupee...

Financial Express, 12th July 2013

On July 8, 2013, the Reserve Bank of India (RBI) stopped all banks from carrying out any proprietary trades on currency derivatives exchanges. This means that all rupee transactions will have to be done only when a client approaches for selling or buying foreign exchange.

On the same day, Sebi doubled the margin requirements for forex trading, reduced client limits from the "higher" of 6% (of open interest) or $10 million to the lower of the two, reduced trading member limits from the higher of 15% or $50 million to the lower of the two.

While the RBI notification states "risk management" as the subject of the regulation, the Sebi circular mentions no reason for carrying out the measures.

Apart from these formal notifications, there have been some other eclectic interventions in the markets by RBI. State-run oil companies have been asked to meet their dollar requirements from a single bank (July 9). It seems banks were asked not to make predictions about the rupee in their forecasts to the public.

The harsh reality is that these actions will not help stem the fall of the rupee; in all probability, they make things worse. These arbitrary moves to curtail economic freedom will only worsen the panic and irrational sentiment in the country. As an example, the only country where economic policymakers interfere with freedom of speech is Argentina. It is not good for India to be one of those who curtain freedom of speech on economic issues.

The rupee has become a big global market that is beyond the control of RBI and Sebi. Since 2007, the trade in non-deliverable forwards (NDFs) in the rupee has soared (see figure 1). These contracts are traded in London, Dubai and Singapore and many other locations. Since the rupee is a controlled currency, the settlement happens in foreign exchange. Indian policymakers have succeeded in crippling the growth of rupee trading in India, but they have no say in interfering with the global trading of the rupee. The overseas market has increasingly come to dominate the rupee (see figure 2).

What the RBI and Sebi moves have achieved is to reduce liquidity in the market. This will allow RBI's intervention to have an impact. But this impact is only in the short run. In the long run, trying to create walls between domestic and offshore derivatives markets for the rupee, or in squeezing the size of the market will have little impact on improving India's competitiveness. The lack of growth in productivity and high inflation will weaken the currency and will come back to haunt the economy.

These moves will, however, make the economy less resilient. RBI and Sebi are successful in reducing access to risk management for small companies in India. For any reasonable-sized organisation, the highway is open to take money out of the country and participate in the overseas market.

In the 1970s, Indira Gandhi's government used to think that food price inflation was caused by hoarding of food. Stringent actions were taken against speculators and hoarders. These made no difference to the supply and demand for food. We now recognise that such authoritarian actions are useless in obtaining cheaper food; the path to cheaper food lies in deeper initiatives that increase productivity in agriculture.

In a similar fashion, the government's assault on the rupee market is inspired by the idea of attacking market participants when the market price is considered undesirable. This will fail again. The price of the rupee is ultimately about supply and demand, and about India's prospects. It is convenient and fashionable for policymakers to blame market participants, but the deeper cause of the rupee's decline lies in the macroeconomic mismanagement including high inflation and large deficits. Until those fundamentals are addressed, the rupee will not improve.

The vast global market for the rupee will gladly lap up all the participants that are driven away from the market within India. RBI and Sebi can drive rupee trading out of the country; they cannot prevent it. Indian policymakers will ineffectually preside over an empty and irrelevant corner of the global market for the rupee. It is ironic that recent moves by RBI and Sebi will accentuate their irrelevance.

India has rapidly integrated with global markets. The rupee and the Nifty are signs of the performance of the economy. When economic policy goes astray-as it has in recent years-this will generate instant feedback with a drop in the rupee and Nifty. This is a healthy feedback loop. It immediately brings pressure upon the political authorities.

Emerging markets have understood these lessons. The economic policy apparatus of mature emerging markets knows that it is judged by domestic and global financial markets every day. This pressure has resulted in attempts at improving institutional structures. When bad things happen, the currency and equities are punished. The job of the government should be to try improving the policy frameworks. We, in India, have yet to come to the point where policymakers read these signals as weaknesses in the economy that they need to address.

Losing currency

Indian Express, 10th July 2013

To shore up rupee, policy must boost domestic productivity, assure foreign investors

The sharp decline in the value of the rupee in recent days has led to a clamour for the government to do something. But there are few easy options available. RBI intervention is likely to have limited impact in the face of the huge pressure on the rupee caused by global capital movements. Domestic interest rates cannot be raised to attract foreign inflows because of the decline in growth and investment in the country. Reducing imports though imposing restrictions on gold has had limited effect. The falling rupee is a consequence of global developments as well as a sign of longer-term features of the Indian economy. Addressing the symptoms, that is, the rupee fall, could give us short-term relief, but soon the same problems will surface again.

First, let us place the rupee decline in perspective. When we compare the slide of the rupee to the behaviour of other currencies in June, when the rupee depreciated sharply, it appears as if other emerging economy currencies depreciated less, while the rupee fell sharply. However, when we compare the rupee-dollar rate to other large emerging market (EM) economy currencies, like those of Brazil, South Africa, Korea or Turkey over a longer period, starting in January 2013, we find that most of those currencies had depreciated earlier, particularly between mid-February and mid-March, while the rupee had held up. The US dollar trade weighted index shows similar trends. As a consequence, what appears to be a very sharp depreciation compared to other large EM currencies is not such a sharp depreciation. Indeed, if the rupee had not depreciated, it would have lost competitiveness against other currencies. With high inflation continuing to plague the Indian economy, the recent depreciation has prevented the real exchange rate of the rupee from becoming overvalued. As long as inflation in India is higher, in the long run we are likely to get a nominal depreciation that would prevent real exchange rate appreciation. So if our cost of production is growing at 10 per cent while, say, for the sake of argument, the others are at zero, then after five years, do not expect that the rupee will remain at 60. It should be expected to depreciate. By how much will depend on capital flows to and from India. For instance, earlier in the year, foreign capital continued to flow into India and the rupee did not fall.

The short-run approach to reducing the pressure on the rupee has been to curb imports of gold to lower the current account deficit. Recent evidence suggests two trends. First, official imports of gold have declined. Second, gold smuggling has increased. Government policies to reduce gold imports are aimed at official imports. It is not clear why the government believes that a shift from official channels to smuggling will solve the question of the inflow of gold or its impact on the rupee. It might have the naive faith that total gold imports will go down if restrictions are imposed, and the criminality it introduces into the system is a worthwhile price to pay for reducing the pressure on the rupee. But gold imports are a means of capital flight. If households do not have attractive assets to invest in, if real interest rates on bank deposits are low, if the real estate market is full of black money and scams, gold appears to be an attractive asset for households. Restrictions on gold have not made the rupee stronger.

Ultimately, a currency gets stronger if the economy witnesses higher productivity growth than the rest of the world. During the months that we have been worried about the rupee depreciating, the Chinese yuan has been appreciating. In addition, domestic inflation in China is high and wages are rising. This offers India an opportunity to step in when China inevitably loses its share of foreign markets. But for this, India needs to remove hurdles to the growth of large-scale industry in toys, textiles, engineering goods, household appliances and various consumer durables. This will involve changes in the exit policy of industry, labour laws, policies on foreign direct investment, removal of the infinite obstacles to investment, improving infrastructure such as power, fuel, raw material supply, ports and airports. Addressing these can give us higher productivity growth, which in turn would give us a strong rupee. But these are difficult problems to fix. India has barely begun to understand the problems we face in these sectors. We are far from fixing them. In all probability, we will helplessly watch Bangladesh, Pakistan and Vietnam step into China's shoes.

Today, India can achieve very little export growth through export subsidies or by directly pushing exports, even if the WTO rules allowed that. Most of the problems that stop domestic producers from becoming more productive and export to the world market are policy and infrastructural issues. Until now, our approach has been to boost exports by making policies to help "exporters". That approach needs to change towards policies that lead to an increase in domestic productivity. It is when firms become more productive that they start serving foreign markets. The challenge today is to create an environment in which more firms become productive.

Another element of the reform India needs to undertake urgently is to clean up its foreign investment framework. Today, the framework is so messy that even the government finds it hard to enforce its own rules. The alphabet soup of FDI, FII, FPI, QFI and so forth has no clarity and the legal uncertainty in the system is so high that it manages to turn away even those investors who want to bring money into India.

The time for quick fixes is over. The RBI must be complimented on seeing the problems of trying to implement a peg to the USD back in 2007-08 and moving to a floating exchange rate. Had Subbarao not been wise enough to do that, India would have faced a balance of payments crisis in trying to defend the rupee.

How to cap the CAD

Financial Express, 28th June 2013

The deficit in India's balance of payments in 2012-13 remained just below 5% of GDP. At 4.8% of GDP, though extremely high by historical standards, it brought a sigh of relief to those watching the external sector. Today, the pressure on the rupee to depreciate is largely a phenomenon caused by an appreciation of the dollar against its major trading partner currencies. If the balance of payments had turned out to be even worse than 5%, which has pretty much already been factored into currency markets, there could have been an additional worry about the country-specific pressure on the rupee that might be around the corner.

Indeed, the good news is that in the January-March 2013 quarter the balance of payments situation for India improved. In the third quarter of 2012-13, the balance of payments deficit had risen to 6.7% of GDP. In the fourth quarter it fell to 3.6%. Again, though this appears very large by historical standards, the improvement is welcome.

The improvement came about primarily because of higher exports, though there was also a small decline in imports. The recent rupee depreciation is good news, as it would help to keep exports competitive. Most other currencies have depreciated and if the rupee had not depreciated then this increase in exports could be threatened. However, service exports are down and hopefully a weaker rupee would help.

The balance of payments statistics shows that the net invisibles have recorded a sharp decline. In the corresponding quarter a year ago they grew at 27.5%. In Q4 of 2012-13 they declined by 7.7%. This behaviour is consistent with the increase in import of gold. Low real interest rates make it unattractive for households to send money to India in the same way that it encourages them to buy gold. When growth crashes and investment opportunities within a country are weak, the attractiveness of the domestic currency declines. This, along with a high inflation rate that has persisted for many years now, is responsible for weakening the attractiveness of the rupee.

The consolidation of the central fisc would also have played a role in keeping the current account deficit (CAD) under control. After P Chidambaram took over as finance minister there has been a drive to control expenditure. This drive has resulted in fiscal deficit below targeted, and in controlling aggregate demand in the economy. This would help in preventing a spillover of demand.

While the news that the CAD is below 5% is good, it still remains a matter of concern. India is financing the CAD by attracting foreign portfolio investment. With the withdrawal of the quantitative easing (QE) programme by the US Fed, these flows may recede. The SEBI board has moved forward to implement the simplification of the foreign institutional investor framework that was proposed by the UK Sinha committee report. This is a positive development. However, the task is not over yet.

First, there are problems in the know-your-client norms, which are proposed to be different for different categories, and it remains to be seen if individuals are easily able to access Indian equity markets as the framework aims to do. Second, the debt market still remains riddled with bad design and quantitative restrictions. Unless these are removed, we are actually blocking off one channel for which India can be an attractive investment destination-rupee-denominated sovereign debt. Third, India will need to move to residence-based taxation if it wants to attract flows as effortlessly as the OECD countries do. Every few months an enthusiastic tax officer or a minister of state wanting to increase revenue collection starts talking about scrapping the Mauritius treaty. This creates uncertainty in the market. This problem cannot be solved by signing a new treaty as that too could come under such cloud; it can be solved only by the country moving to a tax regime where foreigners are not given such tax uncertainly. The move to reduce the withholding tax on foreign debt to 5% is a good one. But the next move will have to be to remove it altogether.

Is the large CAD a temporary phenomenon, or is it here to stay? In 2011-12, the deficit was 4.2% of GDP. In 2013-14, it is 4.8% of GDP. The coming year could do well if exports pick up further. So, for example, if the US economy does well then it should reflect on the demand for exports from India. In that case, our CAD could be lower. However, we should not merely depend on this. Reform in fuel and fertiliser price policies and fiscal consolidation will help control demand. On the other hand, better growth and investment opportunities and lower inflation will make India a more attractive investment destination. At the same time, India needs to get rid of the maze of capital controls that it has created so that the country becomes a more attractive destination for foreign capital.

Don’t try to control the rupee

Financial Express, 21st June 2013

---

Quantitative easing by the US Federal Reserve has been accompanied by high volatility in global financial markets. Most emerging market currencies have witnessed volatility since 2010. The rupee has been among them. In recent days the rupee has moved towards the level of 60 to a dollar. Figure 1 shows that while the Chinese renminbi has remained strong, other emerging economy currencies like those of Turkey, Brazil, South Africa and India have all depreciated in recent times, with most of them seeing a similar amount of depreciation. The South African rand has depreciated more, but the Indian rupee has moved as much as most of the other large emerging economies seen in the graph.

Given the scale of the phenomenon, the first point to note is that this is a global phenomenon. So, while India has its problems of policy paralysis and stalled investment projects, the rupee has not depreciated solely because of domestic issues. This is not to say that we should not have better economic policies, but to argue that on its foreign exchange policy what India needs is not to try to control the value of the rupee or its volatility in the foreign exchange market, as much as to understand what is the impact of these policies on growth and how can we make the economy resilient to sharp movements in the rupee.

When the rupee moves, there are gainers and losers. Among the gainers are those who export to the world. Figure 2 shows the real effective exchange rate of the rupee. This shows that the rupee has not appreciated like the Chinese renminbi has, or depreciated like the South African rand has, but roughly remained stable. The real effective exchange rate is what determines export competitiveness. There has been domestic inflation in India, and what has kept Indian exports competitive is the rupee depreciation. If like the Chinese currency, the rupee had also not depreciated, today Indian exports would have been even less competitive. From the point of view of the exporters the depreciation has merely compensated for the higher domestic inflation in India. Exports have a positive impact on growth.

However, when we turn to the losers, there are two major categories of losers. First are importers, whose prices go up. To the extent that some of these importers are exporters, they get compensated. Others may pass on their higher costs and the consumer is the one who ultimately pays.

The second are companies who may have borrowed in dollars. If companies were mindful of which currency their revenues are primarily going to be in, then in the high volatility environment, companies with export revenue borrowing in dollars would not be in trouble as they would have a natural hedge. But if companies that were earning in rupees such as infrastructure companies saw an opportunity to borrow cheaply, and chose to take the currency risk on their balance sheets, they will be in trouble.

In this respect, the liberalisation of the external commercial borrowing regulations to allow infrastructure companies to borrow abroad was not sensible. Infrastructure companies facing difficult domestic conditions, stalled investment projects, difficulties in clearances, with balance sheets that are already troubled should have been discouraged from taking on foreign debt. Anyway, if companies chose to take the currency risk they will have to pay back more in rupees. Considering the high volatility in the market, the large current account deficit, the poor growth rate of the Indian economy, it is not obvious that many companies would choose to bet on a currency that could easily depreciate when capital flows out. The reduced confidence in the Indian rupee both on account of domestic policies and on the macro environment of low growth and high inflation was pointing to a possible depreciation of the rupee.

The economy performed poorly last year. While some estimates point to an increase in growth in the coming year, the high volatility in the rupee and the impact this will have on corporate balance sheets may indicate a performance weaker than what one might expect.

What should the policymakers do? At present, the only thing possible is to push through the long-promised reform measures on financial markets so that companies are able to hedge their risks and become resilient to shocks to the currency market.

Modi's food security test

Indian Express, 14th June 2013

Is the BJP ready for a new economic philosophy? Can Modi give it?

With his appointment as the BJP's poll panel chief, Narendra Modi is being decisively propelled into national politics. Whether as prime minister or as the leader of opposition in Parliament, Modi will no doubt move from Gujarat politics to national politics. But regardless of which role the BJP plays after the elections, of ruling party or of opposition, it will need a clear and well-articulated economic philosophy.

In the two terms of UPA rule, India has seen more entitlement programmes and a bigger shift towards a welfare state than ever before. Although when the NDA was in government the BJP focused on public goods such as building highways, when in opposition, it failed to oppose policies that were against its politics. Indeed, it opposed some of the very initiatives that it had taken when in government, simply because it was now an opposition party. The GST, which the NDA had proposed as a reform that would give India a single market, was opposed by the BJP. It also failed to support the pension reforms bill that it had proposed to give India a defined contribution scheme, replacing the defined benefits scheme of the Congress era.

Not only did the BJP fail to support the reforms it had proposed when in power, it also failed to oppose largescale entitlement schemes like the NREGA when they were introduced by the UPA. While the role of the NAC as an extra-constitutional body was attacked by BJP leaders in their speeches, when it came to its stance in Parliament, the party seemed to lack any economic philosophy. Not just that, when it has discussed the NREGA in Parliament or state assemblies, it has supported the policies, demanding better implementation. For example, the BJP's concern has been that the full amount of money allocated under NREGA has not been spent.

Was the party going along with the Congress's entitlement programmes because it actually believed in them? Was it not opposing them believing that opposing such entitlements would make it lose popular support? In other words, was silence a populist strategy to avoid a negative impact? Or did the BJP believe that supporting them would somehow translate into votes for its governments in states which implemented them well? In this way, the Centre would spend the money, and the BJP government at the state level would benefit.

The food security bill is the latest entitlement programme proposed by the Congress. Even though it is seen as a vote-fetching flagship programme of the Congress for the 2014 general election, the BJP agreed to support the bill, though it has disagreements on small issues in it. This lack of opposition to legislations promising entitlements has characterised both terms of the BJP as an opposition party. Modi's recent speeches suggest that he believes in small government and does not support such entitlements. With Modi as leader, will the BJP's policies change?

It is likely that the BJP will still shy away from articulating its economic philosophy. It may take the easier way out by fighting the 2014 election on the plank of Modi's governance in Gujarat. However, once Modi moves to the Centre, the 2020 election cannot be fought on the Gujarat governance platform. Even a mid-term election will be hard to fight on the basis of a chief minister's performance in the past. The policies of the Congress have given us a crash in GDP growth. If Modi believes in growth, he will inevitably have to question these policies and not just their implementation.

So if Modi is playing for the long run, seeing his appointment as poll chief of the BJP as his entry into national politics, he may take the option of defining an economic philosophy that distinguishes the BJP from what he calls the "crumb throwing" Congress. He may choose to offer an economic vision different from the muddled philosophy the BJP displayed as an opposition party in the last two Lok Sabha terms. His leadership of the poll strategy offers him his first opportunity to do so. The first impact of such a decision should be seen on the BJP's position on the food security bill, which appears likely to be introduced in the monsoon session.

While Modi may or may not become PM, there can be no doubt that he will, from now on, play a role in national politics. If the NDA does not win the election, the BJP could again become the opposition party, and Modi the leader of opposition in Parliament. Some element of the support Modi receives from corporate India is based on the belief that he will be able to offer India what he has been able to offer Gujarat, a focus on infrastructure and a functioning government that provides investment opportunities. At the same time, an element of the disillusionment of industry with the Advani-led BJP stems from its its failure to play the role of a responsible opposition party. The disenchantment of industry with the Congress is ultimately about bad delivery on GDP growth. Whether as ruling party or as opposition, the BJP will need to shift gears to think more carefully about being a part of the Indian growth story, and not just mindlessly block legislation or the functioning of Parliament. If the BJP continues to misbehave, then industry will also get disenchanted with it.

If Modi fails to lead his party to victory in 2014, and becomes leader of the opposition in Parliament, he will get the opportunity to play the role of a responsible opposition and change the image of the BJP as a disruptive party. His time in Parliament will also offer Modi a chance to distinguish the BJP's ideology from the entitlement-based ideology of the Congress.

The crucial question is whether this is the right time. Is the BJP ready for a new economic philosophy? Governance issues and easier issues like FDI in retail, where the BJP already opposes the Congress, may be much discussed in debates on the BJP's manifesto. But the first test of Modinomics will be the BJP's position on the food security bill. That would be the beginning of the end of the BJP's muddled era.