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A. Seshan

Perhaps for the first time in recent memory, the Mid-Term Review of Monetary Policy of the RBI was a non-event. Major measures had already been announced a few days back by the Finance Ministry taking the sheen off the document.

A spokesman of the Ministry even said that there won’t be any need for a further cut in Cash Reserve Ratio (CRR). There is a certain straw in the wind. From recent developments one can guess that the making of monetary policy is no longer with the central bank even for the sake of form.

The role of the RBI appeared to be only secretarial in arranging to issue the circular to banks announcing the decisions taken by the Government. As expected, the Mid-Term Review has left all the rates unchanged.

There is a detailed reference in the two documents of the Bank to the international financial crisis arising out of the sub-prime problem. But they are silent on the Indian exposure thereof. The central bank itself has deposits in foreign institutions.

But it is to the credit of the RBI that, sensing trouble, it reduced its funds placed with foreign commercial banks and External Asset Managers (EAMs) from $35.3 billion at the end of September 2007 to $6 billion at the end of March 2008 by shifting them to the safe havens of foreign government securities, central banks and international financial institutions. The Indian citizen would like to know the current position and the extent to which RBI has suffered financial loss, if any.

The rationale for releasing the cash reserves of banks is given by the RBI. The paras relating to the liquidity crisis do not admit its role in aggravating it through intervention in the forex market to support the rupee.

If the idea were to enhance the liquidity flows it could have unwound the Market Stabilisation Scheme where the Government has to make substantial interest payments instead of releasing bank reserves that are interest-free.

Of course, the Treasury Bills and dated securities have different periods of maturity. But the RBI could have thought of a quick Debt Buy-Back Scheme for which it has the necessary experience.

From all the data available on money supply, non-food credit, etc., it is clear that there was really no financial crisis in the system calling for a massive intervention. Never in the past has so much money as Rs 1-lakh crore been released at one time from cash reserves by the central bank. The supplementary demand for grants of government mentions Rs 1.05-lakh crore as the additional cash outgo above the figure in the budget.

Was the release of Rs 1-lakh crore from cash reserves decided with a view to helping the Government raise the money in the market? The hint of a hyperinflation referred to in a previous article may sound alarming and even sensational to some critics (‘Is the RBI going overboard to ease liquidity?’ Business Line, October 22).

In the Mid-Term Review of October 22, 2001, there was a 2-percentage point reduction in CRR in two instalments — the highest till then — from 7.5 per cent to 5.5 per cent. The additional money injected into the system was estimated at only Rs 6,000 crore.

Money multiplier was then 4.52 against 4.96 now. Swimming in so much liquidity banks would naturally like to utilise them for earning incomes.

The Government would do well to absorb a part of the liquidity as early as possible through market borrowings. If necessary, the Statutory Liquidity Ratio (SLR) should be raised to meet its requirements so that interest rates do not harden again.

The Fiscal Responsibility and Budget Management Act, 2003 prohibits the RBI from buying government securities in the primary market. However, the RBI can always think of some financial reengineering to help its owner. Thus it has released Rs 25,000 crore to banks against the Government’s debt waiver scheme. It can also enter into an off-the-record understanding under which banks can subscribe to the primary issues of government with a subsequent purchase by the RBI in the secondary market soon after.

One device it had already found was in buying oil bonds against forex, in what it called ‘the secondary market’, even though there was no primary market! Although it is not in the latest documents, the RBI had earlier indicated the possibility of repeating this scheme.

Where is the need in a context where the system is flooded with money? It would be unwise for the central bank to part with its declining reserves. It refers to the ‘cover’ for external debt by indicating its reserves at 141 per cent of the former.

The real cover that is a measure of solvency in the external sector should have portfolio investments of FIIs also added to debt in the denominator. Then the cover will be less than 100 per cent, which is a danger mark from the point of view of the rating agencies.

The chickens of the monetary excesses of October 2008 will come home to roost in 2009. Depositors, especially senior citizens, would do well to take advantage of the high rates on term deposits offered by banks now.

Those who have money should invest in mutual funds (MFs) with good record and in blue chips, the values of which are attractive.

Net asset values (NAVs) of MFs are low or below par in many cases. This is the right time to invest the maximum (Rs 1 lakh) in an Equity-Linked Savings Scheme of an MF to take advantage of the tax relief available under Section 80C of the Income-Tax Act. It makes sense, especially for salaried employees, to take long-term loans from banks for housing so that they can realise substantial capital gains at the end.

The real burden of debt will decrease with inflation. Investment in physical assets such as gold is also inflation proof. The ambience is not favourable for financial savings.

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