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WITH AN EYE TO THE FUTURE

The latest monetary and credit policy of the Reserve Bank of India governor, Bimal Jalan, is framed in the background of a robust external account and benign inflationary situation, albeit confounded by rising government borrowing requirements and structural rigidities of the banking system. Jalan seems determined to keep softer interest rates. He has announced a reduction in the bank rate by 0.25 percentage points and contributed nearly Rs 3,000 crore of extra liquidity into the system by lowering the cash reserve ratio by 0.25 per cent. This decision appears somewhat enigmatic considering that the latest data show a firming up of inflation numbers and high liquidity. But he may well be justified if inflation trends continue to be benign.

Jalan pointed out that the annual rate of inflation, as measured by the wholesale price index, remained below 4 per cent till January 2003, before rising to 6.2 per cent in March . But reckoned on an average basis, the annual rate of inflation was lower than last year — 3.3 per cent as against 3.6 per cent. The governor seems to have factored in improvements in price management as a result of global supply improvements and if possible, imports. But, the risk of higher inflation, given a depressed agricultural season, cannot be ruled out. And interest rates then will not remain unchanged. His promise not to change interest rates till October is, however, hinged on an optimistic view of these trends.

Rate of improvement

A reduced bank rate again does not translate itself into an immediate reduction in lending rates. This is because of the rigidity in borrowing rate reflected by fixed deposit rates in vogue in the banking system. Jalan has been trying to change this system to a more appropriate floating rate system, both on the lending and the borrowing side. The effects are still to come. For the present, the policy contents itself with laying down precise guidelines for fixing prime lending rates and making the process transparent. But unless banks translate his intentions to reality, the gap between lowered bank rates and PLRs will continue.

Jalan rightly pointed out that last year witnessed a sharp reduction in food stocks. This has led to a decline in food credit by banks . The cut in CRR by 0.25 per cent comes on top of this increased liquidity and would only aggravate banks’ problems of appropriate disposition of their resources.

The statement takes legitimate credit for the improvement on the external account and the accumulation of reserves. Jalan points out that the accretion to reserves has been mostly through non-debt creating flows — increase in exports of goods and services.

Legitimate concerns

This in turn has involved the release of domestic currency by RBI to corporates and individuals surrendering the forex accretions. The policy statement notes that this counterpart local currency is used by the recipients for further investment in the economy, favourably affecting the industrial economy. Jalan however cautions market participants against keeping their foreign exchanges unhedged. This is a welcome warning. Exchange rate movements cannot be guaranteed to be unidirectional.

The governor has taken the occasion to express his concerns about the high volume of government borrowings, particularly that of state governments. This makes the task of debt management very difficult. The policy statement was also occasion for a series of desirable relaxations in forex transactions for corporates and individuals.

Jalan’s policy includes various legal reforms. Chief among them is the reform of the Public Debt Act, necessary for public participation in the gilt market. Financial sector reform also needs immediate attention. Jalan’s monetary and credit policy is an important step in this direction and an essential part of liberalization and modernization of interest rates regulation and supervision. It sets the platform for further phased changes in the financial sector to be brought about at an appropriate stage.

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