The Hindu Business Line : Credit Policy — Sound, fury and substantive issues

The Credit Policy has as much rhetoric as components to deal with issues of import. The Bank Rate and CRR cuts do not appear warranted by the macroeconomic conditions while there has been tinkering and welcome initiatives on other issues, says N. A. Mujumdar.

THE Credit Policy package, announced on April 29, is calculated to create what one might call sound and fury, along with the other components to tackle substantive issues. The reduction of the Bank Rate from 6.25 per cent to 6 per cent and the cut in the Cash Reserve Ratio from 4.75 per cent to 4.50 per cent constitute the former component which has attracted, not unexpectedly, a good deal of media attention.

The macroeconomic conditions did not warrant these changes; there is a surfeit of liquidity in the banking system and the Reserve Bank of India (RBI) in its new-found love for the low-interest rate regime had already brought down the interest rates to historically low levels. But pampering the corporate sector has become one of the main compulsions of political economy since the 1990s phase of liberalisation and financial sector reforms. The changes in the Bank Rate and the CRR may be regarded as yet another step that the Monetary Policy has taken to bow to the new compulsions.

Responding to the RBI signals, some major banks have already announced the reduction in their primary lending rates (PLRs). The corporate sector never had it so good. While admittedly rhetoric — and these charges are no more than that — is part of the policy-making games, the RBI seems to be oblivious to the deleterious impact that such low interest rates would have, in the medium term, on savings. The collapse of the UTI and the moribund capital market have already shocked the household sector.

The other component, which is less glamorous, is the activist role that the RBI has at long last resumed playing in prodding banks, particularly public sector banks (PSBs), to cater to sectors other than the industrial sector. It may be recalled that the new banking culture, nurtured by economic and financial sector reforms, had induced even PSBs to focus on three Cs — consumer credit, corporate elite, and capital market-related activities. Every PSB wanted to cast itself in the image of foreign banks. To lend to agriculture, small-scale industries and the self-employed segment became infra dig.

But this illusion was shattered by the capital market becoming moribund: several non-banking finance companies (NBFCs) withering away; bridge loans, and lending to brokers becoming scarce; merchant banking activities coming to a halt; and mutual funds of many PSBs winding up. In the case of lending to corporates, too many banks chased too few `A' rated companies. In the case of consumer lending, a sort of saturation point was reached.

It was in this kind of a bind that the PSBs found the soft option of investing the bulk of their resources in government securities, and the RBI, as the manager of public debt, encouraged this tendency. Otherwise how does one explain the fact that the maximum yield and government securities soared to an absurd level of 14 per cent at some point? The disastrous results of this confluence of factors are all too obvious. Against the prescribed level of 25 per cent of deposits, the PSBs today invest some 39 per cent of deposits in government securities.

The RBI Governor's Credit Policy statement refers to the medium-term objective of reducing the CRR to 3 per cent, in justification of the present cur by a quarter per cent. One wonders what happened to the Narasimham Committee's prescription of reducing the Statutory Liquidity Ratio (SLR) to 25 per cent. The Governor is obviously conscious of this distortion in the deployment of banking sector's resources but has so far done precious little about correcting the distortion.

The Governor's assessment is very clear: "...overall monetary management becomes difficult when a large and growing borrowing programme of the Government puts pressure on the absorptive capacity of the market. The banking system already holds government securities of about 39 per cent of net demand and time liabilities (NDTL) as against the statutory minimum requirement of 25 per cent. In terms of volume such holdings above the statutory liquidity ratio (SLR) amounted to Rs 1,95,974 crore in March 2003 which is much higher than the gross borrowings of the government. Further, such a scenario exposes banks to substantial interest rate risk which has adverse implications for sustained financial stability. In addition, the increasing interest payments have raised concerns about the sustainability of a large public debt. A reduction in fiscal deficit would release resources for infrastructure and industrial financing, which in turn would help in realising the long-term potential of the economy... ''

From the macroeconomic point of view, what is most disturbing is that such a huge amount of nearly Rs 2,00,000 crore is being diverted away from supporting productive sectors to underpin government consumption — consumption, because the Government of India incurs a large deficit on its current revenue account. This trend, which has become a chronic feature of PSBs, can be characterised as a sort of `sickness' of the PSBs for which the RBI has also to share a part of the blame.

It is against this broader perspective that the following measures announced on April 29 assume significance: Credit for drip irrigation, housing finance in the rural and semi-urban areas, and micro-finance credit to dealers in drip irrigation/sprinkler irrigation system/agricultural machinery, irrespective of the location of the dealer, has been brought under priority sector lending. Similarly, direct finance to housing in rural and semi-urban areas, which is part of priority sector lending, has been further liberalised; now banks can lend up to Rs 10 lakh for this purpose. In the new architecture of the rural credit system, micro credit institutions would play a critical role and it is only since 1999 that the RBI has begun to pay attention to this segment of the financial sector.

Microcredit institutions and self-help groups (SHGs) have been recognised as important vehicles for generation of income and delivery of credit to self-employed persons. Intellectual leadership for promoting this segment can come only from the RBI and not Nabard, which is ill-equipped to deal with such innovative approaches. It is gratifying to note that the RBI, which had adopted a stand-off attitude towards the rural credit system all along the 1990s, has woken up to the fact that the system has become moribund.

These RBI initiatives are indeed welcome. Banks have been advised to provide maximum support to SHGs. The banks SHGs-linked credit programme is a success story. Recently, the RBI had "a wide-raging interface" with a cross-section of micro-credit providers. Pursuant to these interactions, four informal group have been set up by the RBI to look into various issues relating to (i) structure and sustainability, (ii) funding, (iii) regulators, and (iv) capacity building for micro finance delivery. The RBI, according to the Credit Policy, will discuss the recommendations of these informal groups in a wider forum for possible implementation.

Taken together, these measures reflect the RBI's concern for dealing with the substantive issues: How to prod the PSBs to begin to lend more to the rural sector, and to dissuade them from exercising the soft option of investing the bulk of their resources in government securities. The credit-deposit ratio of banks has been hovering around 50 per cent for the last several years, reflecting the new `sickness' of the PSBs, and the RBI should spare no efforts to curve this ailment.

The banking system, particularly the PSBs, must reinvent itself by looking beyond the private corporate sector, and these measures of the RBI would enable banks to do so. As it is the corporate sector is doing well for itself, with export growth as high as 18 per cent and industrial growth inching back to nearly 6 per cent. The flow of bank credit to the industrial sector has greatly improved in 2002-03, with non-food credit registering a very high growth of nearly 18 per cent. The Governor's statement provides a wide-ranging list of particular industries to which the size of credit flow has been increased. Neither the availability nor the cost of credit seems to pose any problems for industrial and export growth. Perhaps, in an unguarded moment, the Governor's statement confesses that there was no need for further softening interest rates: "On balance of probabilities, given normal conditions and overall stability in macroeconomic environment, in view of several structural constraints, the present nominal and real interest rates are relatively low. There may not be significant potential for further sizeable downward movement in interest rates.''

That is how one should separate the rhetoric of Credit Policy from the substantive issues we have referred to above. Another substantive issue with which the RBI has merely tinkered is the cooperative credit structure. In the light of the recent scams in some urban cooperative banks, the RBI has now directed that urban cooperative banks "with immediate effect should not grant loans and advances (both secured and unsecured) to directors, their relatives and firms/concerns/companies in which they are interested".

The question really is why such loans were permitted in the first place? Did the RBI had to wait for the JPC recommendations to act on this issue? The broader issue is that the entire cooperative credit system is in a mess. The cooperative movement has lost its elan of the late 1950s and the 1960s. During this phase, the intellectual leadership for the movement originated largely from the RBI but when the portfolio of agricultural credit was transferred to Nabard, the RBI almost washed its hands off this responsibility.

Nabard is simply not equipped to provide such guidance at the macro level. The cooperative credit system today is rudderless, let alone setting a future course.

This role needs to be redefined and a road map for modernising the system drawn up. The scope of the cooperative credit system in the context of decentralised development through Panchayat Raj institutions, its relationship with micro-credit institutions, with the private sector — all these need to be re-worked out. It is time the RBI appointed a high-power committee to draw up a blueprint for cooperative development.

Finally, the RBI needs to do much move to prod the PSBs to reach out to the rural sector — both farm and non-farm segments. Perhaps, the RBI may think in terms of imposing, formally or informally, a ceiling on the PSBs investment in Government securities, say, 30 per cent of their NTDL. Only such a drastic action could provoke the PSBs to reaching out to sectors other than the three `CS' mentioned above.

(The author is a former principal advisor to the RBI.)

Article E-Mail :: Comment :: Syndication

Stories in this Section
India-China relations: On slow burn

Harassing issues

World trade, post-SARS

Another mission to stop defections

Challenging the US' hegemony

Lull in the tea cup

Credit Policy — Sound, fury and substantive issues

Pension funds

Forward dollar