The Hindu Business Line : Brace up to decode RBI's Delphic pronouncements

Even as the nation waits to decipher which way the RBI chief will turn the money supply valve, Basic Economics offers some key pointers to the action of the central bank that, as Indian Administration: Politics, Policies and Prospects, points out is not always independent. But, then, that may also be a problem associated with liquidity management, as Liquidity Risk: Measurement and Management empathises.

A rallying rupee, unrelenting capital inflows, persistent credit growth, and incessant inflation pressure. Just the right combo of ingredients to invite the inevitable: The central bank's intervention, today. And the company honchos seem to be bracing up already. A recent survey by the industry body Assocham found that many CEOs and CMDs in the real-estate, housing finance and automobile sectors resignedly await tightening measures that the RBI (Reserve Bank of India) would reveal in its annual Monetary Policy. It may be a tough exercise, therefore, for the RBI Governor, Dr Y. V. Reddy, to do what he may rather prefer to: Of not peppering his statement with any surprises.

Well, to those who wonder why we should be sharpening our ears to listen to what the Governor says, Thomas Sowell offers simple explanations in Basic Economics from Basic Books (www.basicbooks.com), in a chapter on `Money and the Banking System'. Such as that the central bank can set the interest rate on the money it lends to the banks, and thus indirectly control the interest rate that the banks in turn will charge the general public.

Owing to the powerful leverage that central banks enjoy, public statements by their Governors, let alone the policy ones, tend to be `scrutinised by bankers and investors for clues' as to decipher which way he is turning the money supply valve. "An unguarded statement by the chairman of the Federal Reserve Board, or a statement that is misconstrued by financiers, can set off a panic in Wall Street that causes stock prices to plummet," says the author. In the opposite, the bourses may turn outlandishly bullish if they hear the bankers' banker sounding upbeat.

Given such drastic repercussions, which can affect financial markets around the world, central bankers have learnt to speak in a highly guarded terms that often leave listeners puzzled as to what they really mean, notes Sowell. "Wall Street and Washington expend megawatts of energy trying to decipher the Delphic pronouncements of Alan Greenspan," fretted BusinessWeek about the former Federal Reserve chief.

While we may say that of Dalal Street and the media, closer home too, it can be helpful to appreciate that uncertainty is a fact of life for central bankers, as Ms Sheryl Kennedy, Deputy Governor of the Bank of Canada, mentioned in her speech titled `Dealing with uncertainty in the conduct of monetary policy' at the Montréal CFA Society on April 12.

"Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic of that landscape," she said, quoting Alan Greenspan. "The task of monetary policy is, and is sure to remain, a challenging one, given the limits of understanding something as complex and dynamic as the modern, globally integrated economy," concluded Ms Kennedy.

Autonomy can be `exhilarating'

While we bask in the comfort that our foreign exchange reserves have bulged to over $200 billion, it may be sobering to remember those days in 1991 when the reserves were at less than $1 billion, and so the government had to pledge a portion of the country's gold to meet import costs. Was the crisis of 1991 a failure of bureaucracy, asks Kamala Prasad in Indian Administration: Politics, Policies, and Prospects, from Longman (www.pearsoned.co.in). "Did bureaucracy warn the political masters? It was clear from inside that they did... Unsound financial decisions responsible for a mess had been taken at the political level despite stiff opposition by the administrators!" The crisis of 1991 was one of policy and its political direction, opines Prasad. "When the securities scam broke out in 1992, laxity at the executive level exposed reluctance to empower the stock exchange regulator SEBI and to strengthen the role of the RBI. Administration could not but move cautiously."

In a speech at the Stanford Institute for Economic Policy Research, on March 2, the US Fed chief, Mr Ben S. Bernanke, observed that the Fed retains the autonomy to set its federal funds rate target as needed to respond to domestic economic conditions. "If the dollar's value were fixed in terms of another currency or basket of currencies, the Fed would be constrained to set its policy rate at a level consistent with rates in global capital markets."

Alas, the level of autonomy that Mr Bernanke operates with may elude his Indian counterpart. In a 2001 lecture titled `Autonomy of the central bank — changing contours in India,' delivered at Indian Institute of Management, Indore, Mr Reddy did present arguments that make `a strong case for central bank independence', but conceded that the issue has not been decisively settled.

"There are powerful forces aligned against according such independence to central banks," he rued. Yet he was hopeful that with emergence of `powerful economic interests in the form of multinationals or dominant domestic corporates and their large stakes in capital markets,' it might be necessary to ensure independence of central bank operations. "In the years to come, the sheer need to improve the efficiency of operations will thrust upon the RBI a greater degree of autonomy and, therefore, a greater degree of accountability. In such a milieu it is essential that the setting of goals and the policy processes will need to evolve in a transparent manner. For the central bank, these will be difficult times but also exhilarating times."

Rhetorical, perhaps, because the only other occasion that we find Dr Reddy in an `exhilarating' mood, going by the archived speeches on www.bis.org, is when he was talking earlier this month at the Bank of Greece, Athens, `the land with which Socrates, Plato and Aristotle are associated'.

Liquidity always comes first

A solid anxiety of every banker, including the one on Mint Street, is liquidity, be it in excess or otherwise.

"Liquidity always comes first; without it, a bank doesn't open its doors; with it, a bank may have time to solve its basic problems," reads a quote of Citicorp CEO cited in Liquidity Risk: Measurement and Management, edited by Leonard Matz and Peter Neu, from Wiley (www.wiley.com).

"Liquidity risk may possibly be the most challenging financial risk," write the authors. "Challenging, not because risk managers don't understand it, but challenging in the sense that risk managers take quite different approaches to the subject."

Liquidity was a continuing theme in `Current challenges to monetary policy making in India' — a speech that Dr Rakesh Mohan, RBI Deputy Governor, delivered on February 13 at the 9th Global Conference of Actuaries, Mumbai. He spoke of an `environment of generalised elevation in asset prices and abundant liquidity,' and of banks' non-food credit `expanding above 30 per cent for the fourth year in succession, driving up money supply'. Liquidity management would receive the highest priority of the RBI, and all policy instruments would be deployed `to ensure appropriate modulation of liquidity,' assured Dr Mohan.

The book by Matz and Neu, written as `a practitioner's guide to global best practices', calls for eschewing a narrow risk outlook. "The single biggest mistake made by liquidity risk managers is focussing intently on day-to-day funding, especially funding costs, while at the same time limiting the scope of the liquidity risk contingency planning for a potential funding crisis."

Contingency planning demands a healthy respect for what we cannot know, insists the book. An apt quote of John Kenneth Galbraith cited in the book reads: "We have two classes of forecasters: Those who don't know... And those who don't know they don't know." Which explains why the smarter banks have drawn up plans ahead of Mr Reddy revving up his vacuum cleaner to suck out excess liquidity from the system.

Robust reads ahead of the credit policy.

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