Corroded fundamentals, not trilemma, is the problem.

The previous Governor of the Reserve Bank, D Subbarao complained about managing the policy trilemma in the economy by which he meant how to control the monetary policy with a convertible capital account and and a flexible exchange rate. Or, how do you set interest rates when foreign currency can flow in and out freely and the value of the rupee is determined by the market. What he forgot to mention, perhaps intentionally, is that markets take their cue from the government, especially completely irresponsible fiscal spending to buy votes. This has led to an explosion of black money, inflation and a fall in the rupee. Since black money can only be invested in properties an enormous property price bubble has developed. A duplex apartment in the posh Malabar Hill area of Mumbai has just been sold for Rs 570 million @ Rs 135000 per square foot. This works out to about $2000 per sq foot while apartments in Manhattan in New York start at $1000 per square foot. The average price of apartments in New York works out at $1300 per square foot with Brooklyn and Queens starting at $150 per square foot. If the US is a $16 trillion economy while we are at $1.9 trillion surely prices of comparable properties here should also be one-eighth of those in the US. So, either property prices should come down by 80% in India or the rupee will fall to compensate for the discrepancy. The new Governor of the RBI has increased interest rates by 25 basis points to 7.5% to bring inflation under control. If the cost of borrowing goes up people will stop buying properties and prices will fall. However, high interest rates make all borrowing expensive thus making it expensive for businesses to borrow money to expand. India desperately needs its economy to grow to create jobs for millions of young people who are coming of age. To get round this problem a new instrument called Asset Based Reserve Requirements has been proposed. In this the RBI could ask banks to hold higher reserves for loans on properties thus selectively increasing interest rates on properties without affecting the rest of the economy. Also this cold be applied to selected areas, say in North and West India, where there is more black money. Of course, there is the danger that the economy could collapse completely if all the black money is drained out of the system. How do you build when the fundamentals are corroded.