The Hindu Business Line : RBI at its transparent best

The RBI continues the tradition of openness and transparency in conveying facts and assessment of what lies ahead. The measures announced on the side of monetary and credit policies and prudential regulation are welcome.

THE Reserve Bank of India continues the tradition of openness and transparency in conveying facts and assessment of what lies ahead. There is no Greenspan-speak, providing scope for interpretations from one end of the spectrum to another, confusing the market in the process. President Truman used to refer to "one-handed economists", who would hem in their policy recommendations with caveats such as "on the one hand" and "on the other hand". Were he alive today, he would have been pleased to see double-handed policy-makers in the central bank of this country.

On the prospects for 2004-05, the estimates of growth in gross domestic product (GDP) and inflation are on expected lines ("Stability of prices or inflation?" Business Line, October 22). While the predicted lower GDP growth rate of 6-6.5 per cent is still satisfactory, given the double whammy of oil price rise and unsatisfactory monsoon shocks suffered by the system, the expected rise in prices of 6.5 per cent, on a point-to-point basis at the end of the year, is of concern. Thus, the Wholesale Price Index (WPI) would rise from 180 at end-March 2004 to 191.7 at the end of the fiscal. The WPI stood at 188.5 on October 9. It means that between now and the year-end, the prices will rise by 1.7 per cent. This appears to be somewhat optimistic, given the uncertainties surrounding crop arrivals in the coming months and the food reserves declining in a year of unsatisfactory monsoon apart from those relating to oil and steel.

By excluding four items — iron ore, iron and steel, mineral oils and coal — which registered high price rises, the analysis shows that the year-on-year inflation rate was 4.2 per cent, as on October 9 against 3.8 per cent on the corresponding previous period. This represents only the direct or primary contribution to the WPI. All the above-mentioned items are mostly used as inputs. For example, of the total steel supply, more than 90 per cent goes into the production of other commodities. Thus, there will be a secondary rise in prices of those commodities consequent to steel prices going up. It requires an analysis based on the Leontief-type input-output matrix for the economy.

There is a clear recognition of two issues in the policy statement — the need to give equal importance to demand management and price stability, on the one hand, and economic growth, on the other. In fact, one gets the impression that the spirit of the statement tilts more towards price stability rather than growth. This is to be seen in the context of the rise in money supply on an annual basis by 14 per cent as on October 1 against 11.9 per cent a year back. Non-food credit rose 11.5 per cent in the fiscal up to October 1 in contrast to 6 per cent in the corresponding previous period. Incremental credit-deposit ratio has set a record at 95 per cent reflective of the buoyancy in the economy leading to higher demand for funds.

The excess investment in Statutory Liquidity Ratio (SLR) securities has come down but still it amounts to 14.7 per cent of deposit liabilities. It provides scope for banks to liquidate the excess investment to meet the rising credit demand. It is going to have a bearish effect on the prices of government securities, leading to a rise in yields. This is especially so keeping in view the fact that till October 21 Government raised only 49 per cent of its gross market borrowings and 29 per cent of its net borrowings.

If the RBI does not want the rates to go up, it may have to take the new securities on its books and resort to raising the Cash Reserve Ratio (CRR) to neutralise the monetary impact. There is, of course, the mandatory pro-forma assurance of the CRR being brought down to the statutory minimum of 3 per cent over the medium term. It is really a long-term aspiration of the central bank, considering the period over which it has been making the promise.

The expansion in money supply is retained at 14 per cent, as announced in the Annual Policy Statement. So far, the growth rate has been of this order. Whether it could be maintained in the remaining months is a moot point. The ironic situation is that money supply increases in both good and bad years. If the growth is good, additional money is required to finance it. On the other hand, if there is a drought on a substantial scale, relief measures by government require additional money.

There is a coalition government at the Centre and the Ministers of various parties therein have different constituencies to satisfy. The programmes announced so far by the Government do not give hope for any moderation in fiscal expenditure. If it comes to the question of the survival of the coalition, prudence may be given the go-by despite the legislation on fiscal responsibility and budgetary management. With a high credit-deposit ratio, the money multiplier goes up, although over a period of time. The estimated growth of Rs 2,18,000 crore in deposits may be exceeded.

According to the policy document "Non-food bank credit including investments in bonds/debentures/shares of public sector undertakings and private corporate sector and commercial paper , is expected to increase by around 19.0 per cent, higher than 16-16.5 per cent projected earlier; the higher credit expansion could be accommodated without putting undue pressure on money supply because of lower borrowing of the Government from the banking sector; in the eventuality of government borrowings being larger, unwinding of Market Stabilisation Scheme (MSS) would facilitate such borrowings." One can only hope for the best under the circumstances.

The measures announced both on the side of monetary and credit policies and prudential regulation are all welcome. The only exception is the declaration to keep the bank rate unchanged. Bank rate is more of a signalling device than a policy instrument under conditions of excess liquidity, as banks have no need to approach the central bank. Some banks have already announced that there will not be any change in lending rates.

Seen in the context of a predicted 6.5 per cent inflation rate, the savers, especially the preponderant class of depositors in savings bank accounts (SBA) of banks, are getting a raw deal. The interest rate on SBA is pegged at 3.5 per cent and there is a negative ex ante real rate of return of 3 per cent, even granting the fact that the account is operated like a demand deposit. The maximum term deposit rate is around 6 per cent. Compare this situation with the recommendation of the Chakravarty Committee that banks should offer positive real rates of return to the saver. Of course, we are no longer in a controlled regime, which was the setting when the Committee wrote the report.

There is only one bad egg in an otherwise good basket. The central bank is permitting commercial bank credit for the non-banking finance companies for financing second-hand or used assets. This is likely to be a source for yet another scam in the banking sector.

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

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