While announcing the policy in January 2010, the Governor, Reserve Bank of India, made an observation that “getting out of an expansionary policy is much more difficult than getting into it. It is like a Padma Vyuha in Mahabharatha –you know how to get in but not many people know how to get out.”
It seems the statement equally holds good when the issue of coming out of a contractionary policy comes up when an unfavourable macro-economic environment exists/persists as of late.
The RBI in its credit policy announced on April 17, 2012, gave a surprise by effecting a 50 basis point cut in its repo rate from 8.5 per cent to 8 per cent with immediate effect as against 0.25 per cent expected and speculated by the market.
Consequent to this, the reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, gets calibrated to 7.0 per cent. Similarly, the marginal standing facility (MSF) rate, which has a spread of 100 bps above the repo rate, stands adjusted to 9.0 per cent.
Further, in order to provide greater liquidity cushion, it has also been decided by the RBI to raise the borrowing limit of scheduled commercial banks under the MSF from one per cent to two per cent of their net demand and time liabilities (NDTL).
The market sentiments more than the macro-economic fundamentals seem to have influenced the RBI's credit policy can only be the explanation for such a sharp cut in the repo rate when all the macro economic factors without an exception are opposite to what the RBI would have wanted.
When the fiscal deficit, current account deficit, inflation level particularly consumer price index inflation, exchange rate, international price of oil and all other external and domestic factors which have a bearing on the FDI and FII investment in the economy are not favourable, the only reason for the RBI to have come out with a policy cut is to give the much needed boost to economic growth by improving the sentiments and confidence of the investing community.
Although, according to the RBI, the decision to ease the policy rate has been based on two broad considerations viz; the economy is clearly operating below its post-crisis trend and there is a decline in headline inflation from 9 per cent in January 2010 to below 7 per cent by March 2012 and non-food manufactured products inflation has dropped from a high of 8.4 per cent in November 2011 to 4.7 per cent in March 2012, actually coming below 5 per cent for the first time in two years, the reasons are not very convincing when the RBI itself admits that there is a need to guard against risks of demand-led inflationary pressures re-emerging.
The RBI had taken series of measures to contain inflation, but the inflation numbers have remained high and way ahead of the RBI's comfortable level fixed at 6 per cent.
The need to put up with an inflation at more than 6 per cent is getting an official recognition is the message that one gets from this policy announcement and this has been endorsed by none other than by the Finance Minister when he advised consumers ‘to learn to live with 6-7 per cent inflation' during his address in the annual CII conference held in New Delhi on the April 17, 2012.
The continued high level of inflation and poor growth of GDP are beyond the control of monetary policy measures alone have been well proved over a period and these monetary measures in the absence of supportive fiscal measures have adversely affected the growth trajectory as indicated by the declining trend observed in IIP and GDP growth.
Infrastructure bottlenecks and other supply related constraints also are other major concerns which do not get the required attention from the Government. The policy rates were revised upwards 13 times commencing from January 2010 and the CRR rates which were enhanced twice during 2010 were revised downwards in two instalments in January 2012 and March 2012 to contain inflation and address liquidity issues in the economy.
When the inflationary pressures continue to persist and upside risks are high in the RBI's own admission, the sharp reduction effected in the repo rate purely from a monetary point of view carries no conviction though it carries a message to the Government to initiate action both from the administrative and fiscal front to facilitate investment and production.
It also satisfies the demand of industry and market to reduce the policy rate as if interest element is a major component of the cost of production.
The policy projects GDP growth at 7.3 per cent which is reasonable and achievable despite the constraints.
The deposit growth projected at 16 per cent and non-food credit growth at 17 per cent compared to the past trend are very moderate and banks have to put in special efforts to attract more deposits and reduce the cost of funds.
The present approach of banks in purchasing short term deposits at high costs instead of mobilising deposits needs to undergo a change and banks should go in for long and durable deposits from a clientele consisting of real savers of money. This requires intensified financial and banking inclusion and introduction of customer-friendly savings and fixed deposits products.
The time has come for banks to considerably reduce the net interest margin by adjusting the rate of interest both on deposits and advances and improving drastically the quality of assets. The tendency on the part of banks to depend on borrowed funds particularly from the RBI to run their business has to be curtailed.
The repo facility should not be a perennial source of funds to lend and invest.
The funds management particularly liquidity management of banks needs to be fine tuned and the cost of funds needs to be brought down to improve the NIM and reduce the lending rates. Since the RBI, as is always the case, has come out boldly with the policy change as desired by the market and the Government, it is now the turn of investors, industrialists, bankers and the Government to do their bit to come to the rescue of the economy and meet the aspirations of the people.
What the economy urgently needs, is improved production and low inflation among other things cannot be lost sight of while clamouring for more concessions and reliefs.
(The author is a Consultant and the views expressed are personal).