The Hindu Business Line : To `firm up' or `calibrate' is RBI's dilemma

In a situation of all price indices showing an upward trend, the Reserve Bank of India must persist with its tightening stance taking the stand that its measure needs time to make an impact, says A. SESHAN. The RBI's policy steps will be calibrated appropriately in tune with the emerging developments. Its dilemma is palpable.

Writing on the magic of words in his New York Times column, William Safire once attempted to decipher the language of the US Federal Reserve System, otherwise known as the "House of Hints". He said: "The word accommodative, closely watched for its appearance or disappearance, means `low interest rates that boost the economy'. What would they use when the policy is to slow down growth to avoid inflation? The word that economists prefer is restrictive, but that word is anathema in the Temple of C Street. `Restrictive' has not only overtones of Nimby — the acronym for `not in my backyard' — but also conjures an image of putting the robust American economy into a straitjacket.

"Therefore, to hint at future restriction, the chosen euphemism has been policy accommodation can be removed... How soon the squeeze? `At a pace that is likely to be measured.' Translation: `one of these quarters, somebody (who, us?) could start restricting, but a little at a time; you won't even feel it.' Use of the adjective `measured' is prudence in action. We will never hear the words `tight money' pass our central bankers' lips. (At the Fed the adjective tight is used only in its informal sense of `drunk'.) Instead of spooking Wall Street with the dread phrase monetary tightening, statement writers at our central bank a few months ago noted that `some further policy firming might be needed'. Not tightening the money; only firming the policy."

`Calibrating' policy steps

The Reserve Bank of India may be in need of some Fedspeak in announcing its policy direction at the bankers' meet this month end. Its favourite word in recent times has been "calibrated". So policy steps will be calibrated appropriately in tune with the emerging developments. Its dilemma is palpable. It is worried about the rising inflation scenario with all the price indices showing an upward trend overstepping its target band of 5-5.5 per cent.

Interest rates are going up after the hike in the Cash Reserve Ratio (CRR) to tackle the runaway expansion in credit not in tune with the growth in deposit resources. There is a turnaround in the liquidity situation with the central bank pumping money on a large scale into the money market in stark contrast to the situation a few weeks ago when it had to mop up excess liquidity through reverse repo transactions.

The call money market rates have shot up to double digits, to 20 per cent, something not seen for a long time. It has broken the corridor of repo-reverse repo rates. It is obvious that there are banks which do not have the surplus government securities to offer as collateral for raising a loan from the RBI.

Overheating economy?

There is a debate if the economy is overheating. The semantics may never be resolved. In the West where up-to-date statistics are available on capacity utilisation in the economy, among other things, it is easy to answer the question. Overheating refers to a situation where capacity limits are stretched and a spurt in aggregate demand could result only in a rise in prices and not in production, in the short run.

We have no reliable measures of capacity utilisation. And it is not helpful in the case of the agricultural sector where the monsoon decides the outcome of output and prices in general. The Government has cautioned manufacturers against the trend in rising prices of their goods. What is more heartening is the fact that the Finance Minister has brought down the threshold of "tolerable" or "acceptable" inflation rate to four per cent. This is certainly a great improvement from the days when both Ministers and official economists took comfort from the fact that inflation had not yet reached double-digit levels.

Price revolution

While talking about inflation one needs to point out the price revolution happening quietly in the menu cards of the ordinary restaurants. In the last one month the price of a cup of coffee in Grade III restaurants in Mumbai has gone up from Rs 7 to Rs 9-10 and that of a plate of lowly snacks like "kela bhajia" from Rs 13 to Rs 18. So is the case with other dishes and meals. This is a matter of great concern for the millions of people, especially bachelors and those living alone with their families in their native places, who depend on such restaurants. It is a trend that no price index captures at the moment.

Occasionally one detects an undertone of apology in the statements of central bank authorities for the steps they have had to take. They should be bold enough to say that rising inflation is around the corner and they do want rates to go up to control the expansion of money supply caused by the explosion in bank credit.

The tone of apology is understandable because the RBI was accused of spoiling the growth party in the mid-1990s through its restrictive measures (the forbidden expression) to tackle inflation and ushering in a recession. Now the economy is said to be poised for a growth of 8 to 9 per cent. Even after discounting the hype one may expect to see 7.5-8 per cent, which is by itself good after a high growth year.

What is the way out for RBI?

What should the RBI do under the circumstances? It should persist with its current measures without any change. The pace of credit expansion has not slowed much from the scorching 30 per cent seen earlier. It is certainly very much above the 20 per cent growth that the central bank is comfortable with.

However, according to anecdotal evidence, rising lending rates seem to have adversely affected advances in the consumer durable sector and housing/real estate caused by the rises in lending rates pari passu with those of deposits apart from the CRR hike.

The RBI can take the stand that its recent monetary policy measure needs time to make an impact and it would wait for a few more weeks before any further steps are initiated. The money multiplier, determined by the CRR, is not instantaneous. The enabling amendment to the Banking Regulation Act to remove the floor for the Statutory Liquidity Ratio (SLR) is a step in the right direction.

Too early to speculate

It is obvious that right now the Union Government is not as dependent as in the past upon this mandatory requirement of bank investments in its securities to raise resources.

However, it is too early to speculate on the turn of events in the next financial year until the Budget is presented. SLR helps in getting bank funds for the borrowings of State governments also. They can no longer look to the Centre for any stopgap arrangement to deal with financial difficulties as they have to go necessarily to the market for any balance needs after getting funds under the National Savings and the Plan/non-Plan schemes.

The RBI would do well to think of reducing the requirement of 25 per cent of deposits to be invested in approved securities in its April review after it gets an idea of the market borrowings of the Centre and the States in the next year and the money available from all sources. In the meantime it can continue to provide funds through the Liquidity Adjustment Facility.

(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. The views expressed are personal.)

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