Jalan & #39;S Great Rope Trick
It started with a bang and ended with a whimper. Bimal Jalan broke away from the past and converted his mid-term 'review' of monetary and credit policy for financial year 2002 to an actual 'policy' but the measures announced are not as potent as they seemed to be.
The basic understanding with which the policy has been formulated can be termed as "non-negative": there will not be a downside to the measures. But there may be an upside to it. So it is an exercise worth undertaking in these troubled times. The positive mindset is missing. And since the cuts lack conviction, it turns out that these are half measures, at best.
Prima facie, a two percentage point cut in banks' cash reserve ratio (CRR) and half a percentage point cut in the benchmark bank rate are the stuff dream policies are made of. But have a look at the fineprints.
A two percentage point CRR cut is effectively translated into a 80 basis points (one basis point is one hundredth of a percentage point) cut as the Reserve Bank of India has recast the CRR structure by withdrawing all exemptions given to banks on this front. The net result of this?
The actual inflow of funds into the system will be Rs 8,000 crore and not Rs 20,000 as it would have been under the old CRR structure. In effect, the CRR has come down from 6.3 per cent to 5.5 per cent and not 7.5 per cent to 5.5 per cent.
The second important measure -- half a percentage point cut in bank rate -- may not immediately translate into a lending rate cut. The central bank itself is unsure about the effectiveness of the bank rate as a signaling device.
On the one hand, it says the bank rate continues to remain the "principal signaling instrument" in the RBI's arsenal and, on the other, it makes no bones about the fact that banks have already reached the threshold level and are in no position to bring down their lending rates further, given the rigid interest rate matrix in the financial sector.
The recent reduction in deposit rates and return on small savings have caused widespread concern among depositors because of lack of other risk-free avenues for financial savings, says RBI. This constrains the ability of banks "to effect further reduction in their lending rates" without effecting their deposit mobilisation and the growth of financial savings over the medium term. This is quite a candid admission.
"In view of the rigidities in cost, spread and tenor of deposits, the link between variation in the RBI's bank rate and the actual lending rates of banks, particularly at lower levels, is not as strong in India as in industrial countries," says the policy document. It does not stop here. It goes on to say, "PLRs of banks for commercial credit and entirely within the purview of banks... and decision in regard to interest rates have to be taken by banks themselves."
This is a classic instance of 'saying' things without 'meaning' it. Unlike US Fed chairman Jalan is not willing to commit future rate cuts if today's measures do not work. He cuts the bank rate but does not expect this signal to be transmitted and banks are not in a position to effect a lending rate cut. Does he want the entire business of monetary policy to be an academic exercise? Is it a tacit admission by the RBI governor that the policy has lost its relevance?
At best, the central bank expects the twin measures to prop up the sentiment. On the flipside, a too expansionist monetary policy can create a liquidity overhang in the system. But the RBI has an array of instruments -- ranging from repo (both one day, three-day as well as 14-day), reverse repo and OMO (open market operations) -- at its disposal to ward off the downside risk.