The Hindu Business Line : Credit Policy: More bark than bite

The MSS proceeds are reduced from the RBI's credit to Government, whereas one's understanding is that they are sterilised balances. It also seems unfair to include securities held by the RBI against liquidity support to banks as credit to Government.

The quality of the Credit Policy document continues to improve significantly with every new release. It is a masterly summary of money, bond and forex markets as well as the risk profile of the economy and the banking system.

It therefore comes as a surprise that, after dire warnings of the need to "modulate aggregate demand," an "environment fraught with pressures... embodied in rising bank credit, high asset prices, ... above-trend growth in monetary aggregates as well as global risks from... higher oil prices," the Policy blandly states that "in view of the current macroeconomic and overall monetary conditions, it is considered desirable to keep the reverse repo rate unchanged at 5.5 per cent."

What has probably given succour to the RBI is the declining trend in inflation in recent weeks. Of course, a major factor in this is the Government's decision to hold the line on petroleum prices. But, once the State elections are over, all-round increases are more or less certain.

Liquidity

The document makes it obvious that the prime cause of the tight liquidity in January and February was the IMD redemption of Rs 32,000 crore. The mop-up of excess liquidity through MSS bonds probably went overboard and was compounded by the deliberate slowdown of Government spending to reduce the revenue deficit.

The Policy defines liquidity overhang as outstanding under LAF, MSS and surplus cash balances of the Central Government. As far as one's knowledge goes, the MSS balances are sterilised (that is, the Government cannot spend them). And the Government's cash balances too only have the potential to add liquidity, if spent. The repo-ability of MSS bonds (and for that matter excess SLR investments) with the RBI is also, if one is right, subject to the central bank's discretion.

"Overhang" is a term better used to describe a situation of surplus liquidity — recall 2003 and 2004 — where the reverse repo rate is above the call money or CBLO rates, - something which has not prevailed for most of the first quarter of 2006.

Again, para 23 states that the MSS proceeds are reduced from the RBI's credit to Government, whereas one's understanding is that they are sterilised balances. It also seems unfair to include securities held by the RBI against liquidity support to banks as credit to Government.

It is clear that there are several dimensions to liquidity — the right to it (for example, RBI export refinance), discretionary access (for example, reverse repos with the RBI), liquidity that arises from potential Government spending... the list can go on.

Forex reserves

Turning to the forex front, a marked difference between India and China is that their reserves are growing much faster than ours. We have added at best $10-20 billion in the last year while theirs hasvevaulted $100 billion.

With the rising oil bill contributing to a sharp increase in the trade deficit and draining our reserves, we are in need of a comprehensive energy strategy.

The Policy sets an inflation target of 5-5.5 per cent. Does it imply that if this is not exceeded, there will be no further stiffening of interest rates?

Overall, the Policy's bark is worse than its bite.

In any case, the RBI presumably reserves the right to act pre-emptively on the up or downside if emergent conditions warrant.

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