The Hindu Business Line : Monetary Policy Quarterly Review

Not wanting to take away the punch bowl when the party is going strong, and because of the macroeconomic uncertainties engendered especially by the rise in oil prices, the RBI has kept all its key rates unchanged much to the relief of banks and markets. The only major change it has effected is in raising the capital adequacy for bank finance for real-estate and stock market. This is as it should be, says A. Seshan.

Waiting and watching, the RBI Governor, Dr Y.V. Reddy.

THE FIRST quarterly review of the Annual Statement of Monetary Policy released by the Reserve Bank of India (RBI) can best be described as sedate. Obviously, the RBI does not want to take away the punch bowl when the party is going strong. Despite uncertainties on the macroeconomic front buffeted by the rise in oil prices, the macroeconomic environment exhibits stability. This has prompted the RBI to keep all its key rates unchanged to the relief of banks and markets. The only major change effected is raising the capital adequacy ratios for bank finance for real-estate and stock market.

This is a timely step considering the hectic pace of the growth of bank finance in these sectors. Though the RBI has set low ceilings in terms of the percentage of total credit for lending to these sectors, the underlying amounts are large. Any bursting of the asset bubble could have a destabilising effect on the system. Recent transactions in the Mumbai real-estate market with mill land being sold at Rs 80 crore an acre raise the question of their viability and the ability of builders to recoup their expenditure in a situation where there is so much of large-scale construction of commercial and residential premises going on. There should be an enquiry as to how much of these high-cost land transactions have been financed by bank credit. The other point of worry is the ongoing stock market boom with the indices setting ever new records. The price-earnings ratios of many shares are unreal and provide a leverage to speculators to indulge further in their activities.

The RBI expects the GDP growth rate to range from 6.0 to 7.2 per cent. The range has to be meaningful if it is to be taken seriously. The underlying figure of GDP is massive and even a one-tenth-point rise implies a huge amount. In the past, the RBI used to predict the rate within a range of a half per cent. It should stick to this practice. A benign view has been taken of the progress of monsoon and its impact on agriculture. The delayed monsoon resulted in lower acreages in the sowing of important food crops of the kharif season. As of now, indications are that, barring sugarcane and jute, there may be shortfall in agricultural production. Late sowing has its own limitations in relation to productivity.

On the money supply front, the RBI's view is somewhat complacent despite caveats. It takes credit for the fact that, as on July 8, on an annual basis, the growth in M3 at 13.9 per cent, net of conversion, was lower than the projected 14.5 per cent for the year as given in the Annual Policy statement. The annual projection was for the financial year (April-March). In the current financial year, up to July 8, M3 rose 5.4 per cent (Rs 1,21,399 crore) compared with 3.9 per cent (Rs 77,514 crore) in the corresponding previous period. This is high growth both in absolute and percentage terms. The proper comparison should be after annualising the rates. The year-on-year increase in reserve money at 18.1 per cent, as on July 15, compared with 14.4 per cent a year back and the liquidity overhang of Rs 1 lakh crore are pointers to problems on the price front in the near future. These could get aggravated if there is inadequate precipitation in September, which is crucial for the flowering kharif crops. There is a statement to the effect that supply-side pressures on inflation conditions in April eased in May and June, pulled down by the effect of higher prices last year as well as various monetary and fiscal measures to stabilise inflation expectations. Should one draw comfort from the base effect in looking at inflation? In fact, nowhere else in the world one comes across the base effect as an argument in technical literature in explaining inflation or its rates! In any case, looking at the matter from a practical point of view, it is no comfort for the citizen to be told that the rise in prices is due to the base effect!

The fiscal situation has remained quiescent thanks to some deceleration in expenditure. Whether the pace will remain the same the rest of the year remains to be seen, especially in the context of the Assembly elections coming up within a year in important States and the normal tendency to start new projects, besides accelerating the progress of the existing ones, ahead of the hustings. Considering the pick-up in non-food credit, it is a moot point whether the Government will be able to raise resources in the market without paying significantly a higher interest rate.

The Quarterly Review also refers to the rising trend in yields on government paper. The investments of the banking system in government securities (under the Statutory Liquidity Ratio) have come down to 36.3 per cent of the demand and time liabilities, as on July 8, 2005, from 42.3 per cent a year back but continue to remain above the minimum SLR of 25 per cent.

By not making fresh investments in securities when deposit liabilities increased, the banks have been able to finance the resurgent demand in non-food credit as a result of which the incremental credit-deposit ratio was above 100 per cent on occasions in the recent past.

It is the insurance and provident fund sectors that form the bulwark of government securities market now. However, there is still scope for banks to reduce their SLR investments by more than 10 percentage points. It is, therefore, reasonable to expect the rates on government securities to harden in the remaining part of the year.

The Review was issued without the fanfare of a meeting of bank chairmen at the RBI. The RBI should consider dispensing with the bankers' meeting for the half-yearly and annual reviews also. In these days of computers and the RBI itself putting up the Review by noon on the day of its release it does not serve much purpose to spend time, resources and energy for bank chairmen to assemble at the RBI just for getting a personal copy of the document.

They will need to study changes in consultation with their colleagues and ask for clarifications which cannot be done immediately. This applies to the press conference also. If a meeting is to be convened it could better be done along with a press conference a day after the document is published. Incidentally, Mr Alan Greenspan has never addressed a press conference in his 18 years as Chairman of the US Federal Reserve System. The only time he appeared on TV was to participate in the Larry King show.

(The author is a former officer-in-charge in the RBI's Department of Economic Analysis and Policy.)

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