The Hindu Business Line : An attempt to rein in ballooning inflation

Given the RBI's worry over the inflationary situation, the measures it has adopted — raising the repo rate and provisioning by banks — are the least of all possible evils. One can only hope that with the rabi harvest prospects and the declining global crude prices the emerging situation will enable a more kindly view of the inflationary conditions, says S. VENKITARAMANAN.

MONETARY POLICY REVIEW

The debate on overheating — whether it exists or not and whether it needs tightening of the Monetary Policy — has been resolved for the present by the Reserve Bank of India taking definitive action to increase the signalling rate of repo by 25 basis points and by raising the provisioning requirements for select lending areas.

The policy statement clearly mentions that the signs of overheating demand that credit is high and asset prices are on the rise. The statement also indicates the RBI's continuing worry over declining credit quality in segments, such as housing, consumer loans as well as loans against credit cards.

The abundance of liquidity in the economy, thanks to foreign inflows, cited by the RBI, is in contrast with the tightness that banks have experienced in regard to their own resources. Credit-deposit ratios have been quite high in the recent period. There have been many occasions on which banks have had to borrow from the RBI.

Expensive window

The hike in the repo rate is intended to signal to the banks that it will be costly for them to avail themselves of the RBI's LAF (liquidity adjustment facility) window. Necessarily, this translates itself into an increase in the ultimate lending rate for bank loans.

There is also the reverse impact, in that banks will have no alternative but to raise the deposit rates. The RBI justifies its Monetary Policy stance by citing the inflation numbers, which have crossed 6 per cent (Wholesale Price Index). It particularly emphasises the Consumer Price Index, which is higher still.

The RBI's policy seems set to restrict the growth of credit within the available resources of the banking system. It has introduced provisioning requirements, such as increasing the provision needed for special category loans, in particular credit-cards and capital markets.

It is intriguing to see that the RBI is increasing the provision required against loans to NBFCs (non-banking financial corporations) also. Prejudice against lending to NBFCs seems to persist in the RBI's policy-making circle, although the central bank admits the important role that NBFCs can play for "inclusive" credit expansion even in respect of micro-finance institutions. Choking off supply of bank credit to the NBFCs, which its provisions signal, can be a recipe for some NBFCs' collapse.

Aiming long

The former US Federal Reserve chief, Mr Alan Greenspan's own reported scepticism on effectiveness of small incremental increases in short-term rates on asset price inflation is well-known. He had felt that if these increases are to be effective, they have to be at the long end and if so they might affect adversely "brick and mortar" industry.

The RBI has also taken recourse to increasing provisions for select categories of loans as a channel for forcing banks to increase long-term rates.

Some observers have pointed out that given the low rate of current return on bank assets, the increase in the present provision itself of 1 per cent on certain assets will mean a negative rate of return on lending. Hopefully, the RBI will enter into discussions with bankers to correct such an anomaly, if one exists.

One has to grant that the RBI has been consistent in its policy view of anchoring its stance on the basis of its inflationary expectation. It is a fact that inflation rates have been higher than the targeted rate of 5.5 per cent.

The victory of Monetary Policy cannot, however, come about without supply-side actions by the government. Growth of supplies itself needs investments in agriculture, manufacturing and infrastructure, besides exports. This requires financing.

Dangers of curbing

Actions to restrict financing — which is what the RBI plans to do — can be self-destructive. What we need is a continuing dialogue between policy-makers of North Block and those at Mint Street.

This has to be carried out well in time for the Budget so that growth target with a moderate rate of inflation can be achieved. Otherwise, the target of the Government of India and the planners of 9 per cent plus growth of GDP will remain a pipedream.

The RBI's statement acknowledges the effectiveness of the action taken by the Government both in respect of tax policy as well as supply enhancements for various commodities and their favourable impact on reducing inflation.

It, however, argues that inflation is particularly a monetary phenomenon and the rate of growth of money supply has been high. It also points out that asset price increases also spill over as triggers for spending through what it calls the "wealth effect".

By and large, given the RBI's appreciation of the inflationary situation, the measures adopted by it are least of all possible evils. One can only hope that with the rabi harvest prospects and the declining global crude prices the emerging situation will enable a more kindly view of the inflationary conditions in the months to come.

Otherwise, for the present, the conflict between the advocates of the growth and monetary policy purists seems to have been resolved in favour of the monetary policy-makers declining to accommodate the needs of economic growth adequately.

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