The Telegraph
Since 1st March, 1999
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- The mid-term review of monetary policy adds to the feel-good factor

The author is former governor, Reserve Bank of India

The mid-term review of monetary policy by the governor of the Reserve Bank of India, Bimal Jalan, for 2002-03 is on expected lines. He has liberalized the monetary policy parameters further by reducing bank rate by 0.25 per cent and cash reserve ratio by a further 0.25 per cent. Whe- ther these decisions will help to revitalize the economy is, however, a question whose answer depends on many imponderables, not the least of which is the behaviour of the monsoons and the development in west Asia, particularly the price of crude oil.

By and large, however, Jalanís mid-term review adds to the feel-good factor. All is well with the world, as he sees it, and it is time to relax the interest rate and let the flood of liquidity flow. Whether investors will come and scoop it up to invest in new projects depends on the animal spirits of entrepreneurs. Jalan has done his best to assure them that credit will be available from all corners for all reasonable projects at relatively low rates of interest. Well, if demand is not growing and global competition is killing enterprises, it is outside the remit of credit policy. It is up to the mandarins of North Block to create an environment that further induces fresh investment.

The policy statement is good as far as it goes. But, it reminds us of the policy dilemmas of all central bankers in todayís world. The Economist, in a recent piece on central bankersí dilemmas, pointed out that they often donít know where they are, let alone where they are heading. Their recent policy dilemmas are the equivalent of not knowing whether the earth is round or flat. The reason for this cloud of unknowing is, according to The Economist, that central bankers learnt their trade in a world whose main danger was inflation. Today, the danger has shifted to asset bubbles and deflation. Whether the weapons of yesterdayís battles will do in the current combination of problems is the question.

Jalan is in no confusion about where he is and where he is headed. He is clear about what his policy objectives are and what his available tools can achieve or not achieve. We must be thankful for his clarity and rationality of policy-making. Not for him the doubts that assail others of his tribe in the world. Jalan has set about slaying the monster of high interest rates, aided and abetted by the governmentís decision on various avenues of savings, including provident funds. He has been emboldened in his resolve by declining inflation, which today stands in terms of wholesale price index at a low of 2.8 per cent on a point-to-point basis as on October 12, 2002, as against 3 per cent a year ago.

The stance in favour of low interest rates is constrained only by the structural factors. Bankers are, in particular, to operate within the structure of the rates they have to offer on their deposits, which are, in turn, affected by competing rates offered on savings. The one obvious way out would be to relax the rate on savings deposits. The governor has urged banks to devise schemes for encouraging depositors to convert their existing long-term fixed deposits to variable rate deposits. This will reduce the currently prevailing downward inflexibility in interest rate structure. This is good news for banks but bad news for depositors, squeezed as they are already.

The governorís decision to reduce the bank rate by 0.25 per cent is more a signaling device than an effective step per se. The bank rate has, by Jalanís own earlier admissions, ceased to have a pronounced impact on economic activity. But, it is nonetheless a yardstick. It measures the cost at which banks can borrow from the RBI as the lender of last resort. It also sets a benchmark for various other rates of interest charged by the government. Change in the bank rate is one way in which the central bank announces its stance on interest rates to banks and the business community. Perhaps, Jalan is also preparing the ground for the government to reduce the remaining administered interest rates, if any.

What is intriguing in the package of Jalanís mid-term review is, however, the decrease in the CRR. In the current situation, wherein there is excess of liquidity with banks, further reduction of the CRR ó which measures the amount banks have to deposit with RBI ó seems counter-intuitive. However, Jalan must be intending this reduction as a further step in his move towards the stationary level of 3 per cent. After all, CRRs are a throwback to the days of financial repression when governments commandeered a part of public deposits either as statutory reserves or CRRs. The step towards further liberalization is, therefore, welcome.

The governorís mid-term policy review notes with a certain tone of self-congratulation that the rates at which the government has raised loans have come down in the recent past. The weighted average yield on government borrowings on dated securities stood at 7.52 per cent this year, as against 9.44 per cent last year. This is definitely good news for the RBIís principal client and owner ó the government of India.

The success of public debt management is measured both by the cost at which borrowals are made, and the case of borrowals. In both respects, the RBI has a creditable record in the current year as in the past. The government has already completed 77.3 per cent of its budgeted borrowings. The borrowing programme of the government is obviously smoothened by the considerable flood of liquidity in the system. The banks, however, hold a substantial excess over their statutory limits, the excess being a mindboggling figure of Rs 1,66,200 crore ó a natural consequence of private borrowings languishing while the public sector borrowing goes on apace.

It is on the external front that the mid-term review of monetary policy has a really good story to tell. The growth of reserves to $ 64 billion is definitely a feather in the cap of the RBI. It gives the lie to various attempts of international gurus to trash Indiaís financial performance. Jalan draws attention to the ongoing debate on the ďcostĒ of holding on to excess reserves. He points out that this cost has to be measured against the risk that lower reserves carry. In particular, he mentions that the reserve accretion has been essentially made at low cost ó through remittances and purchase of export proceeds.

While this is true, the good economist that he is, Jalan cannot ignore totally the argument that it is the cost at the margin that matters. It is my surmise that the marginal accretion to the reserves comes from foreign currency non-resident deposits, whose cost is surely higher than the returns that we get by deploying our reserves ó otherwise they will not flow to India. In any event, the final argument rests with the governorís point that the safety factor conferred by holding adequate reserves far outweighs the cost of holding them at even admittedly low returns. With regard to exchange rate management, the RBI will carefully monitor the exchange rate without a fixed target or a pre-announced target or band. The policy will be a mixture as before ó of creeping float and intervention when necessary.

Jalan gives considerable attention to smoothening export trade operations. He has taken steps to improve export credit delivery and responded to suggestions for refining current practices. He has further liberalized procedures for export credit interest rates as well as on export remittances. These reforms are significant as they show a clearly responsive mindset on the part of the central bank.

With regard to domestic credit delivery, Jalan notes that there has been an upturn in the flow of non-food credit. This indicates a corresponding upturn in business expectation and industrial output. He includes the usual exhortation to the government to expedite the legal reform agenda. One step has already been taken in the form of the securitization and reconstruction of financial assets and enforcement of security interest ordinance. The ultimate test lies in the details of implementation. One hopes that the devil does not lie in the details and that corporate resistance does not derail the well-intentioned reform that seeks to strengthen bankersí recovery processes.

Overall, Jalanís mid-term policy statement is a package of goodies and rests on a well-constructed business model. Whether his initiatives will spur business activity is, however, a different question. The answers will depend on what North Block does.

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