The Hindu Business Line : Some trouble spots highlighted

While it is true that the RBI may have had good reason for not reducing the rate of interest further in its latest policy, the negative impact of the continuous high rates of interest on certain sectors of the economy has to be carefully considered in deciding the future course of policy options.

The RBI Governor, Dr Y. V. Reddy.

S.Venkitaramanan

It has been my practice to review the RBI’s macroeconomic and monetary developments document issued prior to the Credit Policy as it reveals a number of critical insights into the developments in India’s economy. Let us take a look at these aspects.

Negative investment position

My first port of call is the last chapter of the document, which deals with the external front. There is an apparent contradiction between appearance and reality here. While it is true that the foreign exchange reserves have been increasing — they touched $284 billion as of January 2008, — their build-up is primarily due to capital flows and not current account surpluses. These capital flows inevitably involve an increase in liability on the part of India’s economy.

I had mentioned this point in my last review in connection with the last monetary policy statement of the RBI. I had emphasised that the increase in liabilities is rather open-ended with its magnitude increasing whenever the stock market rises and/or the rupee appreciates. This is a double-whammy for the net investment position of India, which would tend to get more and more negative, although the level of reserves may indicate a comfortable position.

The table regarding the net investment position, as disclosed by the document, shows that negative levels as reported in March 2007 and in June 2007 are more or less the same, standing at around (-) $50 billion . — to be precise, (-) $47 billion in March 2007 and (-) $52 billion in June 2007. This builds up towards a negative investment position, primarily as a result of increase in foreign direct investment (FDI) and foreign portfolio investment, both of which increase India’s liabilities to foreign stakeholders. The cumulative FDI up to end of March 2007 is reported to be roughly $72 billion. The statement is careful to point out that these are historical costs.

Double bonanza for foreign direct investor

The foreign direct investors involved in FDI would have invested in industries, where market capitalisation would have necessarily increased over time. Definitely, the figure quoted in the RBI’s report is an understatement, at least by 30-40 per cent if we take into account only the stock market rise in the Indian bourses. Add to this the effect of rupee appreciation. A foreign direct investor has received a double bonanza.

The same is the story with foreign portfolio investors. The foreign portfolio investment, displayed in the statement, shows a cumulative total of roughly $79 billion as on March 31, 2007, and increased to $93.5 billion in June 2007. Here again, the continued effects of stock market movement and of rupee appreciation have not been factored in. This would lead to the net foreign investment position of India being much more negative than reported.

High forex reserves – a facade

I reiterate my earlier observation that the RBI should at least make a rough exercise on the implications of market-based enhancement of values and the effect of the rupee appreciation. It should not be beyond the ingenuity of the RBI’s capable economists to estimate the effect on our net investment position because of these two factors. What we do or can do about them is a different question, however.

Add to this the fact that the assets of the country, primarily composed of foreign currency reserves, are invested in assets denominated in a depreciating currency and we can imagine the overall effect on India’s position as a net holder of injecting liabilities to the rest of the world.

This is a reflection of the fact that, over the years, the current account position has been showing deficit, albeit at a low level, relative to the GDP. This is being financed by increasing capital flows, which increase our liabilities to the rest of the world. The root of the problem is, again, in the trade deficit, which continues to be large. It is obviously imperative to take steps to increase our exports and maintain our imports at a sustainable level.

Let us not be complacent because our forex reserves are high. They are a facade. Whether the exchange rate policy of the RBI would help in this desirable goal is a billion-dollar question. There is not much discussion in the document on the related issues of whether a rising rupee has affected adversely the exports of goods or services and/or increased the imports of capital equipment and consumer durables.

The credit scene

Turning to the other aspects of the report, it is pertinent to observe that it is, as usual, quite professional in its analysis of the macroeconomic dimensions of India.

With regard to distribution of credit, the tables in the report emphasise the fact that there has been a growth in credit to agricultural sector as also housing and, above all, the bete noire of RBI, viz. loans against Credit Card. The increase has, however, been moderated because of the RBI’s continuous exhortation in this direction.

It is pertinent to point out that in an expanding economy it is not totally undesirable to have credit increases, at least in respect of financing investment and consumer durables.

One of the means for which, is access through credit cards. The total volume of credit on credit cards in relation to the population of India and the rising incomes is moderate. While the observations of the RBI in regard to the need for controlling heavy-handed practices in collection of credit card dues are worth noting, they cannot justify a total reversal of the user-friendly innovation in loan disbursements, which is represented by the use of credit cards. It should be possible in this age of information technology to adjudge the credit ratings of various individuals amongst the credit card holders and help obviate defects.

Impact of high interest rates

The RBI’s document has a telling table on inflationary indicators and rates of interest. India stands as one of the countries with a high rate of interest.

While it is true that inflation is high, relatively speaking, the real rate of interest is also high. No wonder India’s rate of growth is not impressive as that of China where the real rate of interest is lower.

The document shows impressive cash management by the Centre as well as the States. The Government has had surplus cash running into nearly Rs 60,000 crore on January 18, 2008, with the RBI. So is the case of the States, who are investing their surpluses in Treasury Bills.

While fiscal deficit is considered to be inflationary, can it be argued that such hoards of surplus on the part of the Government would per se amount to abstraction from the reserves of the non-governmental sector?

Perhaps the RBI’s expert opinion would differ. Still, such accumulation by Government is surprising in the face of the large unmet needs of the people.

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