The Hindu Business Line : RBI’s Mid-Term Review of economy

While the situation appears to be under control in relation to price stability and growth of various sectors, there is volatility in the stock market and on the external front. Although the corporate sector has been complaining that the so-called tight monetary policy is hurting the economy, recent data show that the country is on course to attain the estimated growth rate of 8.5 per cent this year, says A. SESHAN.

The Reserve Bank of India’s Mid-term Review of the economy on October 30 is taking place at a time of mixed signals.

While the situation appears to be under control in relation to price stability, growth of various sectors, and so on, there is volatility in the stock market and on the external front.

Although there have been frequent complaints from the corporate sector that the so-called tight monetary policy is hurting the economy, recent data show that the country is on course to attain the estimated growth rate of 8.5 per cent this year.

Thus, the gross domestic product at factor cost (1999-2000 prices) recorded a 9.3 per cent growth during April-June 2007 compared with the corresponding quarter of 2006. The rates for agriculture (3.8 per cent), manufacturing (11.9 per cent) construction (10.7 per cent), and trade, hotels, transport and communications (12per cent) were impressive. They ranged from 3.2 per cent to 7.6 per cent in respect of the remaining sectors.

The Index of Industrial Production recorded an increase in output in August 2007 of 10.7 per cent over the year with sub-sectors doing well. The April-August figures are equally reassuring.

Wholesale prices have been quiescent for quite some time at around 3-3.5 per cent leading to an euphoria in some quarters that the demon of inflation has been laid low. But it is a spurious claim considering the non-representative nature of wholesale prices to reflect the burden on the common man.

The index numbers of consumer prices for urban non-manual employees rose, year-on-year, by 6.4 per cent in August; the food sub-group recorded 9.11 per cent. The other consumer price indices tell the same story more or less.

Excess liquidity

The economy is floating on a sea of liquidity. Thus, M3, the broad measure of money supply, rose 21 per cent, as on September 28 compared to 19 per cent a year earlier and the target of 17.5 per cent.

There is a signal for future trouble on the monetary front in the high annual growth of Reserve Money at 26.6 per cent, as on October 12, seen against a much lower 15.3 per cent a year back. Bank credit grew 21.9 per cent although lower than the 30.2 per cent recorded a year back.

If liquidity is interpreted to mean money likely to be available for lending, it adds up to Rs 4,09,524 crore, as of September 28, comprising excess cash reserves (Rs 71,607 crore), excess statutory investments (Rs 1,91,908 crore), Reverse repos (Rs 3,665 crore), funds impounded under Market Stabilisation Scheme (Rs 1,31,473 crore) and government deposits with the central bank (Rs 10,871 crore). (The RBI does not include the first two items in computing excess liquidity.)

Interest rates

It is indeed ironic that anyone should talk about a tight monetary regime with so much money sloshing around. Perhaps, the reference is to the high rates of interest necessitated by the central bank’s policies in recent periods.

Here too facts do not support the view. A large proportion of agriculturists get bank loans at 7 per cent. Most of the large corporate borrowers are able to raise loans at below prime rates. Recent data show that the corporate sector is doing well in terms of the quarterly results of performance.

Let us not forget that interest constitutes a small proportion of production cost. Any increase in the rates affects only profits.

There has, however, been no great slackening in the profitability of enterprises in general. The slowdown in credit offtake due to high interest rates is mostly in the retail sector of home and vehicle loans. But the central bank wanted it that way in devising its policy measures.

If we leave out surplus CRR balances and MSS funds, what remains is still large at Rs 2,06,444 crore.

The excess would have gone up even further since Reverse Repos amounted to Rs 36,730 crore on October 22 and Government deposits with the RBI swelled to Rs 25,818 crore, as on October 12.

The auctions of government papers, amounting to about Rs 20,000 crore during the week ending October 26, would take care of a part of this problem. Still what remains is substantial.

Raising CRR

Interest rates cannot be raised any further given the possibility of further attracting foreign funds despite the recent slide due to the restrictions on Participatory Notes. They cannot be lowered either as it will be contra-indicated. In any case, the banks themselves have started cutting the rates, especially on retail loans, faced with a decline in their offtake. So the remaining option is to keep the policy rates at the present levels. At the same time, something needs to be done to tackle the excess liquidity. There is no other way but to raise the CRR.

While a 50-basis point hike is justified, it is likely to be around 25 basis points to heed the banks’ sensibilities, especially since they do not earn on CRR funds. It will not hurt them. They have cash balances amounting to 9.5 per cent of aggregate deposits, as on October 12, against the required 7 per cent.

Although a part of the excess may be for facilitating interbank clearing settlements they will be able to absorb the rise in CRR without any difficulty, considering that they do not earn interest. This is what happened during the last CRR hike, effective August 4. Would it mean that the CRR rise will have no effect on the situation? It would have a signalling effect to banks on the need to go slow on their operations.

In this context, one does not understand the frequent exhortations from official sources to banks to augment their efforts at deposit mobilisation. What will the banks do with the acceleration in deposit growth? After all, credit creation is money creation. It is a good sign that banks have started lowering the deposit rates.

Forex Problems

Why has the central bank’s sterilised market intervention not prevented the steep appreciation of the rupee by 15 per cent against the dollar over the year?

According to one view, articulated by Frederic S Mishkin, Member of the Board of Governors of the US Federal Reserve System, a sterilised intervention has almost no effect on the exchange rate.

It leaves the money supply unchanged and so has no direct way of affecting interest rates or the expected future exchange rate. (See The Economics of Money, Banking and Financial Markets, Frederic S Mishkin, Eighth Edition, pp 462-464.)

US decisions

Unsterilised intervention can, however, bring about a change in the exchange rate.

Given the hard choice between domestic and external policies, the country may ultimately have to settle down for physical controls on the inflow of funds.

The recent disturbances in the stock market are going to be temporary.

One may expect the inflows to resume before long. In fact, if the US Fed decides to cut down its policy rate at its next meeting on October 30-31, the flood will become a deluge making it necessary for the RBI to undertake further measures in addition to what it may announce on October 30.

Considering the impact of US decisions on our fortunes, it will be a good idea to schedule, wherever possible, RBI reviews a day after the US Federal Open Market Committee (FOMC) meets so that its decisions can be taken note of.

There are two meetings of FOMC on January 29-30 and April 29-30 in 2008, which will coincide with the RBI reviews.

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

More Stories on : Credit Policy | RBI & Other Central Banks

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Will the curbs work?

ESOP norms: Many issues await clarification

RBI’s Mid-Term Review of economy — Walking a tightrope

Campaign against counterfeit goods

Absolute poverty