The Hindu Business Line : More of a stop-gap policy

Token reductions in repo and reverse repo rates will not ease the problem of banks’ reluctance to lend. Closing the reverse repo window altogether would have forced banks to look at alternative avenues for lending and not just invest in government securities.

A. Seshan

The RBI’s Annual Policy Statement for 2009-10 gives one the impression that, in relation to major initiatives needed to solve the ongoing problem of declining growth, it is a stopgap approach pending the presentation of the Union Budget. Thus, there are no sector-specific measures to deal with the problem of declining export demand.

This is understandable, but it is too long a period to wait when problems cry for immediate solutions. The token reductions in the repo and reverse repo (RR) rates would not make any impact on the current situation.

The problem of excess RR operations has been ignored. The lender of the last resort is now acting as the borrower of the first resort for surplus funds.

Demand for credit

There may be a slackening in the demand for credit from the manufacturing and export sectors. But when one looks at the volume of credit transactions in the unorganised market and the high rates of interest at which these are being executed, it is difficult to believe that there is a lack of credit demand.

There are millions of small farmers and small-scale entrepreneurs who do not have access to institutional credit. The suicides by farmers in Vidarbha are being partly attributed to the failure of banks to reach out to them. Hence, some pressure on the banks to lend would have been justified.

Reverse repo window

It was in this context that this writer recommended closing the RR window altogether (Business Line, April 15). It would have forced banks to look for alternative avenues for lending and not just investment in government securities — ‘lazy banking’ as once a Deputy Governor of the RBI called it.

It would have also brought down the lending rates. The 25 basis points reduction in the RR rate is not going to ease the problem of reluctance to lend, especially for banks which have relatively large proportions of deposits in current and savings bank accounts.

While public sector banks have done relatively well, it is the private and foreign banks that have registered substantial declines in the growth rates in lending. . One suspects that it is these banks that are heavy users of the RR window. The RBI may like to do an analysis in this connection. The lowering of the repo rate by 25 basis points is only symbolic and has no teeth as this facility is not utilised in the context of the ample liquidity in the system.

The developed world has embarked on a massive programme of injecting liquidity into the system to raise effective demand and facilitate growth. But, of late, saner voices are heard on the need for unwinding all the excess liquidity once the immediate problems of the crisis are solved.

Mr Allan Greenspan has said: “Even before the market linkages among banks, other financial institutions and non-financial businesses are fully re-established, we will need to start unwinding the massive sovereign credit and guarantees put in place during the crisis, now estimated at $7 trillion.”

A similar view has been expressed in UK too after a rise in inflation. One may not believe in monetarism in its extreme version, which got it a bad name. As The Economist once observed: “Margaret Thatcher did to monetarism what the Boston Strangler had done to the travelling salesman!”

But one cannot get away from the fact that inflation is a monetary phenomenon. Else, cannot the problems of the economy be solved by distributing currency notes all over the country by dropping them from a helicopter?

It is good that the RBI has started giving thought to the question of unwinding the excess liquidity floating in the system due to monetary and fiscal measures.

In para 72, it says: “While the Reserve Bank will continue to support all the productive requirements of the economy, it will have to ensure that as economic growth gathers momentum, the large liquidity injected in the system is withdrawn in an orderly manner.”

Demand elasticity

However, its estimate of money supply for 2009-10 does not bear out its recognition of the need for making a beginning in the right direction. The growth in M3 last year was 18.4 per cent, and that of GDP, 6.5-6.7 per cent.

The RBI estimates the desirable growth in money supply to meet the expected demand by multiplying the GDP growth by the income elasticity of demand for money.

The elasticity used in the estimation is 1.4, according to the information obtained by this writer from the Bank under the Right to Information Act.

It has an unusual practice of adding another 5 per cent to the above-mentioned figure, a la the baker’s dozen, to accommodate an inflation of that order. It only assures the economy of a minimum inflation of 5 per cent.

Thus, a growth in money supply by 14.4 per cent would have been justified last year. On the other hand, there was an excess money supply of about 4 per cent. In the current year, the GDP growth is expected to be 6 per cent and inflation, 4 per cent. Thus an increase of 12.5-13 per cent would have been appropriate as against the 17 per cent provided for.

One has to remember that this is on top of the excess money supply spilling over from last year. The Consumer Price Indices continue to show inflation rates near double-digits. A 4 per cent inflation rate for the current year does not look realistic, as of now.

(The author is a former Officer-in-Charge of Economic Analysis and Policy, RBI.)

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