The Hindu Business Line : A nudge is not enough

The Reserve Bank of India’s third quarter macro-economic and monetary policy review attempted to ride two horses at once; a galloping economy that required one set of polices and a lurching global financial system that needs another. A subdued GDP forecast of 8.5 per cent is still a robust one but signs of exhaustion may already be evident; the Index of Industrial Production fell a percentage point to 9.2 per cent in April-November 2007 while growth in the consumer s ector almost halved to 5.2 per cent. Yet the RBI figured the time wasn’t ripe for any change in rates. On the other hand, global uncertainties and the US Fed rate cut increased the differential between domestic and US interest rates. The resulting capital inflows will impact the rupee and government finances, that will have to shoulder the cost of sterilising the excess liquidity from a system already awash in it. Yet the RBI did nothing because it balanced the likelihood of that strong rupee (and the cost of liquidity mop-ups) against the imports of dearer food-grains and oil.

The assumption that prices can, therefore, be reined in with cheaper imports and a more than comfortable foreign exchange reserve position may work given the current level of headline inflation; even Consumer Price Indices average a little over 5 per cent, a clear drop from the highs of 9 per cent earlier. Given its anxiety about sustaining growth, it is intriguing, however, that the RBI should find it unnecessary for “any significant policy initiatives at this juncture.” The rate of credit growth has declined, as has the total resource flow from scheduled commercial banks to the commercial sector, results of the central bank’s ratcheting of interest rates in recent times. It is even more puzzling that the central bank should castigate banks for excessive investments in SLR securities instead of enhancing credit. Given their sustained profitability “as reflected in interest margins” banks must lend more through institutional and procedural changes. Without saying so, the RBI is nudging banks towards interest rate cuts, a message explicitly beamed to bank chiefs by the Finance Minister some time ago.

So far banks are not buying; most prefer to wait for the central bank’s April moves that, in turn will be influenced by the Budget. Monetary policy then will be aligned not so much with the domestic economy as much as North Block’s take on it. But in the meantime, the productive economy at the margin, those small and medium enterprises and new home-loan borrowers will pay high rates while monetary policy tip-toes around the paradox of excess liquidity and declining credit.

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