The Hindu Business Line : Hands-off, deliberately

The RBI has not, rightly, touched any of the policy rates but it is quite inexplicable that it should be projecting 17-17.5 per cent rise in money supply even as the economy is drowning in liquidity.

The Reserve Bank of India (RBI) has done well in keeping its policy rates unchanged. It has not displayed a knee-jerk reaction to the recent rise in inflation rate. The status quo stance is understandable because it has already taken several hard steps in recent months and they seem to be working. There is always a lagged response to monetary policy measures.

Their result is already seen in the decline of the growth rate of bank credit to non-food sector from 31.8 per cent in 2005-06 (Rs 3,54,193 crore) to 28 per cent (Rs 4,10,285 crore) in 2006-07 exhibiting some moderation from the sustained increases during 2003-06.

Incremental non-food credit-deposit ratio came down to 84.6 per cent from 109.3 per cent the previous year. The substantial disinvestment of excess securities held by banks in relation to the Statutory Liquidity Ratio had been worked out to a large extent from 31.4 per cent in March 2006 to 28 per cent a year later.

However, coupled with aggressive deposit mobilisation — a rise of 23 per cent against 18.1 per cent in 2005-06 — banks are still able to have high levels of credit disbursement. There have been some significant drop in credit disbursements in the areas of special concern — housing/real-estate and consumer durables.

Inexplicable move

On the downside, one does not understand the rationale for keeping the projected money supply growth for the current year at 17-17.5 per cent. Assuming a baker's dozen of 5 per cent being added by the central bank to accommodate an assumed inflation rate of an equivalent extent and the expected GDP growth rate of 8.5 per cent, it would appear that the RBI has assumed an income elasticity of demand for money between 1.4 and 1.5.

Money Supply (M3) growth, on a year-on-year basis, increased by 20.8 per cent (Rs 5,67,372 crore) in 2006-07 compared with 17 per cent (Rs 3,96,881 crore) in 2005-06.

Reserve money went up by 23.7 per cent (Rs 1,35,892 crore) during 2006-07, higher than the 17.2 per cent (Rs 83,922 crore) recorded earlier. Considering the enormous growth in these variables what is now projected for money supply is on the high side and may only sustain the inflationary trend.

There is plenty of money sloshing around and the economy is drunk on liquidity. What is needed is weaning it away from the excess in a gradual manner so that there is no overhang of abstinence if a shock is administered suddenly by way of a severe reduction in growth rate.

According to the RBI, the overhang of liquidity rose from Rs 74,334 crore in March 2006 to Rs 97,449 crore in 2006-07. (The definition of "overhang" needs to be looked into for its appropriateness in the context of policy-making.) Where is the need for another 17-17.5 per cent rise in money supply? In fact, in the past, the projected expansion would be routinely around 15 per cent. In this context the RBI would do well to resume a discussion of trends in money multiplier found in its Annual Report several years ago. The Economic Survey 2006-07 makes a reference to this.

Wheat advances

It is not understandable why the RBI is dragging its feet on imposing selective credit control on advances against wheat. Ever since the marketing season started, on April 1, there have been several reports in many newspapers about the low market arrivals and the low procurement by the Food Corporation of India (FCI) in Punjab and Haryana despite a crop that is supposed to be better than last year's. Farmers have the capacity to hold the harvested produce for a better price as the season advances. They are not satisfied with the minimum support price of Rs 850 per quintal offered by the FCI as they can fetch much higher from private parties — traders, individual and institutional, including the Australian Wheat Board, and manufacturers such as ITC nad Hindustan Lever.

According to Economic Survey 2006-07, bank advances against wheat decreased from Rs 689 crore to Rs 601 crore between March 2004 and March 2005 but rose to Rs 1,332 crore in March 2006 — a rise of more than 100 per cent.

It may be a small proportion of the value of marketable surplus but it certainly revealed a trend towards hoarding the produce with the support of bank credit at a time when wheat prices started rising and the FCI could not achieve its procurement target subsequently.

The RBI should release the more recent data. While the speculator may have other sources of funds to finance his stocks, it still stands to reason that bank credit should not be used for speculative hoarding of commodities.

Forex Pangs

The announcement of liberalisation in allowing funds to flow abroad seems to be motivated by the problem of capital inflows creating a problem in the management of money supply. NRI deposits are also sought to be discouraged through reductions in interest rates. Obviously for both the Government and the RBI the accumulation of exchange reserves is a nuisance. And not long ago we were moaning about the lack of foreign exchange to modernise the economy! Is it not a poor reflection on planning?

After great persuasion the Government has taken a step towards utilising the forex reserves to a limited extent for infrastructure development. It should expand the scope to cover modernisation of the economy. There are several sectors that need to import modern plants and machinery. They could be provided with forex loans by opening a refinance window for banks in the RBI. The interest rate could be what the RBI is currently earning from its investments abroad.

This would also make it easy and economical for many firms to raise forex loans locally instead of through External Commercial Borrowings. It would be money well spent for the country.

There is a substantial proportion of forex reserves which are "free" in the sense of not being repatriable or repayable and hence could be utilised for the purpose.

(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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