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RBI's Currency and Finance Report — Some aspects of credit delivery ignored

G. Srinivasan

The apex bank does not fight shy of telling the Government that "strict adherence to fiscal rules in letter and spirit will help stabilise inflation expectations and, in turn, keep inflation low and stable in the country while gradually providing increasing flexibility to the apex bank".

AMID such economic tidings as the Mid-Year Review of the Economy and the Finance Minister, Mr P. Chidambaram's winding-up the debate on the supplementary demands for grants in Parliament last week, the Report on Currency and Finance 2003-04, released on December 23 by the central bank, missed the usual coverage in media. But this in no way detracted from the words of wisdom emanating from the Mint Street, Mumbai.

The United Progressive Alliance (UPA) Government, headed by the Prime Minister, Dr Manmohan Singh, and his co-reformist Finance Minister, Mr Chidambaram, would do well to read between the lines in the RBI's scholarly document. With the UPA government overly committed to ensuring that agriculture and the vulnerable sections do not get bypassed in the provision of credit by banks, besides lining up welfare schemes for one section or the other in its caution not to estrange popular and prospective vote-banks, the authorities must heed the RBI's wise counsel on these counts.

Even as the central bank is vested with the daunting task of maintaining the right monetary policy stance, the Bank pertinently states that " a prudent fiscal policy remains the single largest prerequisite for monetary stability" as global experience testifies to this. Stating that reforms in the monetary-fiscal interface during the 1990s were a key factor in imparting greater flexibility to monetary policy, the bank has said that these reforms have taken a marked step forward with the enactment of the Fiscal Responsibility and Budget Management Act, 2003.

The apex bank does not fight shy of telling the Government of the day that "strict adherence to these fiscal rules in letter and spirit will help stabilise inflation expectations and, in turn, keep inflation low and stable in the country while gradually providing increasing flexibility to the apex bank". Rightly does the bank explain that fiscal discipline fosters enabling conditions for monetary and financial stability.

When crude oil prices crossed $50 per barrel and point-to-point inflation based on the wholesale price index breached the 8 per cent level, though both declined subsequently, the authors of the RBI report rightly point out that uncertainty about how economies operate and about monetary policy itself, is no excuse for not pursuing price stability.

Enumerating the virtues of how a milieu of sustained low and stable inflation is conducive to financial savings with beneficial impact on investment in the economy and for sustained growth and employment, the apex bank observed that price stability is vital for an economy like India, with a large proportion of poor population that has no hedge against inflation. Inflation is, without doubt, the cruellest form of taxation for the vulnerable and the retired people, who eke out their existence on a fixed income.

Despite the Finance Minister's oft-repeated plea to banks to shed their shyness in lending to farmers, particularly as their repayment record is better than any other privileged sections, the RBI feels that the flow of credit to the various sectors of the economy could be improved further if banks could contain their operating costs and further improve loan recovery. The operating costs of banks in the country remain higher than in other major economies.

Though Indian banks have done `a remarkable job' in containment of non-performing loans (NPLs) considering the overhang issues and overall difficult environment, NPLs remain high compared to international standards. The RBI is, however, optimistic that the improved institutional and legal arrangements, accompanied by concomitant strengthening of risk management practices by banks, are likely to keep incremental NPLs low.

The central bank does not ignore a key challenge on the credit delivery issue, which is to fashion "a market-oriented framework of affirmative action in channelling credit to the relatively disadvantaged sections of society". While this is born out of the need to meet the avowed objective of the present ruling alliance at the Centre, how the banks could evolve such a market-savvy answer to this affirmative action for the poor is left unexplained.

On credit flow to the farm sector, the report underscores the urgent need for legal and institutional changes relating to governance, regulation and functioning of rural cooperative structure and regional rural banks (RRBs). Here the Bank does not push under carpet the inescapable reality that "the changes warranted in cooperatives as well as RRBs involve deep commitment of State governments and have significant bearing on political economy".

The moot question is with State governments reluctant to bring about any measure of efficiency in the functioning of cooperative banks, as they are useful to them in their own way, the repercussions of even a modest reform in this domain will undoubtedly have a tectonic impact on the political economy.

In view of overhang problems of non-performing loans and erosion of deposits in both cooperatives and RRBs, the apex bank states that restructuring and recapitalisation by the Government becomes important. It is anybody's guess that when past debts are restructured or fresh infusion of capital is pumped into moribund institutions, it would only perpetuate ineptitude at the expense of many an honest taxpayer.

The bank also concedes at once that the current acceleration in credit delivery can be sustained in the medium term, "if such fiscal support from the States and the Centre is firmly put in place soon to revive or reorganise the rural cooperative structure and RRBs". With the Government's hands tied down by the provisions of the FRBM Act, 2003 and State government finances being fragile, it would be unexceptionable on the part of the RBI to advocate this sort of subvention in the name of sustaining the government's zealousness in ensuring augmented credit flow to the farm sector.

Probably this would only nullify the bank's prescription for maintaining fiscal rectitude to conduct monetary policy within the ambit it had set itself upon. It is also revealing that while analysing the monetary policy framework in India, the RBI report noted that in the pre-1990s period, prior to the first burst of economic reforms in 1991, credit allocation and administered pricing certainly ensured a reasonable level of credit flow in the desired direction at the desired pace, but at a cost, along with inefficiencies as well as distortions.

In such a situation, the cost had to be borne in different ways, including statutory pre-emption — as high as 63.5 per cent of the incremental deposits of banks in 1992. The banks also persisted with the practice of charging interest rates to various categories of borrowers by their category — agriculture or small scale industry — rather than based on actual assessments of risks for each borrower, despite policies of liberalisation, deregulation and enabling comfortable liquidity.

However, thanks to the RBI endeavour in the past few years to reduce transaction and information costs, credit flow to such sectors is available at reasonable interest rates. Yet, how to price risks remains a riddle wrapped in an enigma for many a banker who has badly burnt his fingers through imprudent decisions in the past.

In a sector reliant on capricious weather and high-cost inputs for farming operations, which banker would throw caution in the winds to bend with the persuasive political masters who might not be there to bail them out when the chips are down or when the monsoon plays truant, which is more often than not? In any case, this year's RBI document makes interesting reading in several real sectors of the economy though its treatment of the credit delivery system and the changes suggested appear to be in conflict.

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