Y. Venugopala Reddy’s first credit and monetary policy has sprung no surprises. He has kept the bank rate and the cash reserve ratio — the important variables governors normally tinker with — unchanged. He has done so for the right reasons. Interest rates are already at an all-time low and liquidity is high. No need to change what is working well. The Reserve Bank of India governor has resisted the temptation to play to the gallery by further lowering interest rates and reducing the CRR.
In an exhaustive analysis of the macro-economic situation, Reddy highlights the robustness of the economy. He notes that the rate of growth of the gross domestic product is likely to be better than what was forecast in Bimal Jalan’s statement earlier this year. Taking comfort from the good monsoons and the better showing of manufacturing, he predicts a GDP growth rate of 6.5 to 7 per cent, compared to the earlier forecast of 6 per cent. A more benign global economic environment also helped to support these forecasts.
Reddy hopes inflation will be around 4 to 4.5 per cent compared to the earlier projection of 5 to 5.5 per cent. Interest rates have been behaving in an orderly manner. Overall, the average call money market rate has come down from 5.86 to 4.64 per cent. The yield on government securities with 10 year residual maturity has come down from 6.21 to 5.11 per cent. Deposit rates have moved from 5.25 to 7 to 5 to 6 per cent in the last half year. Lending rates have also come down, although the prime lending rates of public sector banks remain unchanged. Reddy notes that corporates have been able to borrow at finer rates although the access of small and medium industries to credit remains restricted.
As for the external environment, the increasing reserves offer a shelter in times of crisis. But there is some cause for concern. Exports grew only by 10 per cent compared to 18 per cent last year. On the contrary, imports rose by 21 per cent during the last half year, compared to an increase of 9 per cent in the corresponding period last year. Net result — the current account of balance of payments, which had remained in surplus for the previous year and a half, showed a deficit of $ 12 billion in April-June 2003.
True, the reserves still rose. But, that was due to capital flows. The alarm signal is the worsening of the current account and the contributory factor is the appreciating rupee. I do not see any sign of anxiety, in the governor, as to the implications of this for the health of the external account. An expert group should be immediately assembled by him to advise on how to tackle this impending danger to our foreign exchange self-reliance.
Reddy has announced a number of committees and working groups to carry forward his agenda of reform. Particular reference must be made to the advisory committee on the flow of credit to agriculture and related activities. It has a wide remit, including looking into the functioning of NABARD, RRB and the Rural Infrastructure Development Fund. Reddy also proposes to set up a group on the flow of credit to the small-scale industries sector, which will revisit the recommendations of earlier groups which have gone into the subject.
The governor also proposes to initiate action on the recommendations of informal groups regarding micro-finance. Much depends not only on credit delivery, but also on training the recipients of micro-finance to manage their enterprises. Otherwise, the money given will go down the drain.
Reddy has done his best to loosen the shackles on the credit delivery system. A lot depends on the overall state of the economy, if investment impulses are to be realized. That depends on the way the governments behave both at the Central and state levels.
Reddy’s first credit policy does everything to convey the impression that all is well with the economy and can be even better. The only fly in the ointment is the exchange rate, which threatens to be worrying, thanks to the abundance of inflows. The policy itself can do little to cure the ills of this development. Hopefully, in the coming months, Reddy will devote his energies to reverse the ill-effects of such appreciation.