A Policy For All Seasons

Not so long ago, the Reserve Bank of India (RBI) was being criticised for an unnecessarily tight monetary policy which would hurt growth while achieving a transient reduction in the inflation rate. With the inflation rate continuing to remain at low levels as per the wholesale price index (WPI), critics pointed to the high rate as per the consumer price index (CPI). Now with the CPI inflation rate at 4.7 per cent, critics blame the RBI for the poor growth rate. After three years of a 7 per cent growth rate, a 6 per cent growth rate in 1997-98 should hardly be deemed low. Critics then turned the heat on to the RBIs obsession with containing M3 expansion. Resisting all these pulls and pressures and yet proceeding with the reforms is no easy task. The governor, by reaffirming his earlier M3 target of 15.0-15.5 per cent for 1997-98, has not yielded to analysts who have argued that there is no relationship between money, income and prices and that we could safely increase the M3 expansion to 18 per cent or more.

 

The nation owes a debt to the governor for his stout defence of prudence at the cost of being at the receiving end of unwarranted criticism. While the deposit growth estimate for 1997-98 has been retained at Rs 80,000 crore (15.8 per cent), the total flows of funds from banks could accommodate a 20 per cent increase. We should, however, not hold this up as a credit projection but merely as a confirmation of the fact that there is ample availability of credit for creditworthy borrowers. While maintaining overall monetary growth within earlier limits indicated, sufficient attention has been given to sectors like housing and auto-finance which have large multiplier effects, and this policy announcement is probably the first formal statement in many years that credit for the distribution channels is important. It is pertinent to note that Dr Rangarajan was a key member of the Chakravarty Committee, which also stressed this point.

The interest rate signals, though anticipated or wished for, are nonetheless of great significance. The bank rate is now at 9 per cent -- the lowest level in 16 years. While a number of interest rates are linked to the bank rate, there are two inexplicable anomalies. First, there is no reason whatsoever to discriminate against state co-operative banks by charging them 2.5 percentage points above bank rate. This is an anomaly which should be immediately rectified. Second, it is stultifying that 92-day Treasury bills with yields less than 7 per cent and dated securities with yields of over 11 per cent are provided support at the same rate. This is no way to develop the Treasury bill market.

The deregulation of interest rates on domestic term deposits for 30 days and up to one year is a significant measure and it is to be hoped that banks will use the discretion with maturity and judgment. They have to recognise the bank rate signal while determining their own deposit rates. It is hoped that there will not be any formal or informal suasion on the fixation of rates and that banks will fix these rates judiciously. To the extent that banks have asset-liability maturity mismatches they can rectify this by suitably structuring their deposit rates for different maturities. A chronic borrower in the call market may wish to pay a higher rate at the short end of the deposit maturity structure, while a chronic lender in the call market could offer lower rates at the short end.

The 2 percentage points reduction in the cash reserve ratio (CRR) should not be construed as throwing caution to the winds but as a major shift from direct to indirect instruments of monetary control. The bulk of the governments borrowing programme is over and even if there were some further borrowings, the RBI would be able to so modulate its open market operation as to maintain the desired monetary control.

While all these three major policy initiatives are needed commendable, my fear is that the change in the interest on cash balances will open up old wounds and the RBI would find it very hard to hold down the interest rate on CRR balances to 4 per cent. But all this would become redundant if the RBI progressively moves towards the objective of a 3 per cent CRR! In the literature on the subject it is sometimes argued that there are costs of supervision and cost of running a payments system and it is justifiable not to pay interest so long as the CRR is kept low. Having reduced the CRR from 15 per cent to 8 per cent, there was no case of yielding to the pleas of banks for higher rate of return on their cash balances.

The simplification of the statutory liquidity ratio is welcome, particularly as it no longer distinguishes between resident and non-resident deposits. Likewise, the RBI should quickly move over to a uniform prescription on CRR and it certainly should not fix a lower effective CRR on non-resident liabilities.

The insistence on bill finance for settlement of dues of SSI suppliers is indeed to be commended, but it is hoped that the operating instructions will carry some punitive measures for borrowers who default on this stipulation.

The Indian psyche has all along considered trade as the villan of the piece and although in recent years vituperation against trade finance has stopped after the Chakravarty report -- there is no proactive policy favouring trade credit. The present policy, for the first time, sets out a positive signal favouring trade credit.

The measure on bridge loans is of some concern. The measure is silent as to what type of company it relates to. It is fervently hoped that it relates to non-financial companies. It would be disastrous if the measure also relates to financial companies.

The policy has far-reaching measures on development of financial markets and the liberalisation of the capital account. These are of great significance and deserve separate treatment.

On balance, it would be fair to say that while ones own predilections would lead one to disagree with certain measures, the overall stance warms the cockles of ones heart.