Rbi Hamstrung By Political Compulsions

Prime minister H D Deve Gowda wants interest rates on farm credit to come down; finance minister P Chidambaram advocates concessional credit for exporters; the industry ministry, for its part, recommends a three to five per cent cut in the cash reserve ratio. Never before in the past has the countrys central bank been subjected to the kind of political compulsions while framing its monetary policy.

As the general belief that the economy is headed for a slowdown gains acceptance, both the industry and the commerce ministries have pressed the panic button. Export growth has fallen to 11.45 per cent in April-July, less than half the growth recorded during the corresponding period last year.

 

Alarmed by the signs of a slowdown in growth, the industry ministry feels that drastic steps are called for to sustain the momentum generated last year. Add to this the United Fronts commitment to accord the highest importance to the agriculture sector, and one gets a fair picture of the central banks predicament at the busy season monetary policy 1996-97.

The industry ministrys recommendation is based on an analysis of several factors: drying up of the equity market making debt the only available means of corporate finance; aggressive government borrowing programme squeezing the corporates out of the debt market; high interest rates; and, corporates shying away from bank credit despite two cuts in the prime lending rates by a majority of the public sector banks.

But can hefty cuts in CRR as recommended by the industry ministry be the panacea for an economy beset by problems? The answer is an unequivocal no. For every percentage point of CRR cut, the central bank can inject an additional Rs 4,000 crore into the system. The more the merrier syndrome will fuel inflationary pressures.

As a senior banker puts it, you cannot have the cake and eat it too. The RBI cannot effect drastic cuts in the CRR and yet expect to contain inflationary pressures, which has been the primary objective of the central banks monetary policy over the years. In other words, it will have to choose between growth and stability.

Interest rates can come down and boost industrial growth if fund infusion takes place through CRR cuts. But the growth will be achieved at a cost the shooting up of the wholesale price index. The industry ministry has blamed RBIs excessive concern for inflation control for the current state of affairs. A certain amount of inflationary pressure will be just right for the Indian model of economy, it has argued.

Chidambaram has stated that the government will ensure that inflationary expectations are dampened, thus easing real interest rates in the economy. There is no denying that inflationary expectations have a great bearing on long-term interest rates.

Money at the long end can become cheaper only when inflationary expectations come down. But can the UF government, with its motley group of politicians at the helm of affairs, ensure that?

Bankers are convinced that the primary reason behind the decline in net bank credit is the shelving of the investment decision by corporates, and not the cost of funds. Only political stability can prompt corporates to take the plunge and, consequently, boost non-food credit in the industry.

Another highly politicised segment is priority sector credit. Deve Gowda is in favour of lowering farm credit, while Madhu Dandavate, deputy chairman, Planning Commission, feels RBI should fix pragmatic interest rates in priority sector lendings.

In a recent interview to this paper, Madhu Dandavate said, It is necessary to strike a balance between lending and deposit rates, and agreed that the exercise would result in a light increase in lending rates in the priority sector in the short term.

The UF governments concern for agricultural lendings is prompted by dismal growth in the farm sector in 1995-96. Between April 1995 and February 1996, agricultural crop production is estimated to have grown by 0.9 per cent against a 12.4 per cent growth in industrial production.

The RBI governor has already directed bank chiefs to raise firm credit by over Rs 2,500 crore this year. Over the past few weeks, the prime minister has asserted at various fora that lending rates for farm credit will come down.

If the central bank succumbs to pressure and lowers lending rates on small loans, the move may backfire as no banker will entertain the thought of hitting priority sector lending targets at the cost of the bottomline of the bank.

The best way to ensure the flow of farm credit will perhaps be linking it to the PLR, which has been a long-standing demand of the industry.