The Hindu Business Line : Further reflections on the Credit Policy

AT FIRST sight, the latest Credit Policy seems a "do-nothing" statement, leaving the crucial bank rate and cash reserve ratio unchanged. It has, however, the bells and whistles, the attachments in respect of institutional changes, provisioning norms and procedural reforms, which indicate the direction of reform. It has neatly confined them to a separate section.

This is called "the annual statement of developmental and regulatory policies for the year 2005-06". These reforms are at least as important as the decisions to keep the investment and cash reserve ratio unchanged, as announced by the Governor in the first part.

Turning to the statement, the Governor lists the priorities in regard to system improvement under four or five broad heads. First, he proposes to debate the current regulations on interest rates and stipulations regarding the priority sector in terms of their effectiveness in delivering adequate credit at appropriate prices.

Second, he stresses the need to develop the money, forex and government securities markets. Then, there is the need to bridge financing gaps in agriculture and small and medium industries. Fourth comes the need to secure sound governance practices, better risk management and adherence to prudential norms.

Fifth comes the strengthening of payment and settlement systems, including the development of the use of information technology. Finally, he stresses the importance of ensuring availability of quality banking services to all sections of the population.

Quite an ambitious agenda!

Referring to interest rate prescriptions, the Governor discusses the progress of deregulation of interest rates in recent years. He notes the progress in deregulating rates on deposits, which are by and large left to bank managements, except in regard to NRI deposits whose interest rates have been linked to Libor.

The debate on deregulation of deposit rates, in general, has been going on for decades. Essentially, banks are afraid of competition ruling the roost. The RBI is rightly cautious in this regard.

So far as lending rates are concerned, the RBI notes that interest rates on small loans up to Rs 2 lakhs are linked to banks' prime lending rate. It has been argued that such lending rate regulation has effectively dampened the larger flow of credit to small borrowers.

The central bank notes that the current regulation imparts an element of downward rigidity to banks' prime lending rates.

Hopefully, the RBI will reconsider this stipulation. So far as export credit is concerned, the Governor notes that it is important to ensure that regulation of interest rates does not restrict credit flow. Having stated the issues and whetted our appetite, the statement ends as a damp squib by concluding that it is proposed to continue with status quo on issues pertaining to the interest rate regulations while the debate is on. It is comforting that the RBI is keeping an open mind.

Regarding the money market, the apex bank's statement rightly stresses its importance. It indicates certain changes being made in access to the call/notice money markets. Non-bank participants will be entitled to lend, on an average, up to 10 per cent of their average daily lending in the call/notice money market in 2000-2001.

It seems to me, however, that such an arbitrary restriction on participation in the call money market has no logic in a liberalising environment. A much freer access to the call/notice money market is needed lest the participants find other ways to get round the regulations.

In regard to the government securities market, the RBI has indicated its decision that open market operations would become a more active policy instrument. The Bank's latest statement visualises various steps to implement these changes.

Referring to the important issue of separation of debt management functions from the monetary authority, the RBI notes that discussions are on with Government regarding this subject. It seems premature to pursue this ideological will-o'-the-wisp for doctrinal reasons. After all, the central bank has not so far allowed its debt management role to impinge on its monetary policy aspect. When something is working well, why change it? "If it ain't broke, don't mend it" is a good American saying, which holds good here too.

In regard to the forex market, the policy statement notes that certain liberalisations will be introduced. They include the following: For one thing, cancellation and rebooking of all eligible forward contracts booked by residents, irrespective of tenor, will be allowed. This is a much-needed reform. Banks will be allowed to approve proposals for commodity hedging on international exchanges from corporate customers — a very desirable change with India Inc. integrating with the world.

The RBI will also provide for dissemination of information regarding trading volumes for dematting, such as foreign currency rupee options into the market. These are significant moves, incidentally showing progress towards making our capital account more effectively convertible. Reform by stealth, but reform nonetheless!

Similarly, a much-applauded initiative in regard to allowing overseas investments up to 200 per cent of the net worth of a corporate is also included in the RBI's statement. Truly, a path-breaking announcement, which frees our corporates, especially software majors from unnecessary regulatory restraints on expanding into the wide world of investment opportunities!

Regarding credit delivery mechanisms, the Governor's statement is quite frank. It acknowledges the weakness in the system and proceeds to address them. What is disconcerting is that the recommendations of the Expert Committee under Prof V. S. Vyas in regard to agricultural credit are still under consideration of Government.

Among these recommendations are proposals for negotiable warehouse receipts system, setting up of an agri-risk fund and computerisation of land records.

An intriguing suggestion in the paper is to allow Nabard to access external commercial borrowing. It is not at all clear. How Nabard will hedge its forex and interest rate risks? After all, Nabard needs rupee resources. Why access ECB? Rural lending is still the Achilles' heel of the banking system and the RBI is still struggling with ideas and study groups — not to mention an indecisive Government that is examining various reports for years!

Among the proposals for improving delivery of credit, there is a mention of allowing Self Help Groups (SHGs) engaged in micro-finance to access external commercial borrowings (ECBs). Whether micro-finance institutions as a class will have the ability to negotiate with ECBs in the best terms is a matter of serious doubt. They are, by their very nature, non-governmental organisations.

While the Bangladesh model of SHG — the Grameen Bank network — does accept foreign aid in the shape of grants, I do not know any precedent for SHGs in micro-finance accepting commercial credit from abroad. I believe this proposal requires more serious reconsideration.

In regard to credit flow to SSIs (small-scale industries), the RBI has a sensible proposal relating to the involvement of SIDBI much more closely with their financing.

The crux of the financing problem of SSIs lies in reactivation of State Finance Corporations, which continue to be imperilled by large non-performing assets.

In regard to Regional Rural Banks (RRBs), the Governor's statement proposes to encourage the merger sponsored by them State-wise. When the identity of the RRBs as individual institutions is lost, how will they continue to perform their mandated role?

Referring to priority sector lending, the Governor's statement has some observation. It mentions a pertinent question as to whether lending for infrastructural projects should be eligible for priority sector lending. It admits that credit flows for infrastructure has been strong. It does not come to a definite conclusion on this vital question.

It is significant that the Governor's statement emphasises the interest of depositors as paramount. It mentions the fact that "bank offerings" are generally opaque.

What they charge and do not charge is not mentioned. The hidden costs are rampant. The statement is frank enough to say that if a small customer goes to a bank and has a technical problem, he has to pull wires.

Anecdotal evidence suggests, says the RBI's statement, that he runs into enormous difficulties. There is substance in the widespread impression among the depositor community that "one needs to know someone higher up for getting a job done".

This is perhaps more true in the case of a small borrower. If this anecdote is true, how difficult is it to get credit flows increased to the SSIs, agriculture, and so on?

Referring to what it calls "financial exclusion", the RBI's statement notes the need for ensuring that vast sections of the population, such as pensioners, self-employed and those in the unorganised sector, are not excluded from bank lending.

Referring to customer service, the RBI's statement endorses the idea of setting up an independent Banking Codes and Standards Board on the model of the mechanism in the UK to ensure fair treatment of customers and depositors. Yet another institution does not seem necessary. The Ombudsman Scheme should be revitalised.

Overall, the RBI Governor's statement on developmental and regulatory policies is comprehensive, shows an open mindset and, therefore, promises prospects of an effective reform.

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