RBI’s unanswered questions

The Annual Report of the Reserve Bank of India for 2012-13, released recently, bears the imprimatur of the Central Board of Directors. Thanks to the competent staff, it is authentic in facts, figures and analysis, though one may not agree with some of its views.

Is there a choice?

The year was as difficult as any in the recent years with the options before the Bank in policymaking being limited in the context of the eternal choice between growth and price stability. The Bank has pointed out more than once that it is only a short-term conflict and, in the long run, price stability promotes growth.

The Report refers to the RBI being faced with the Hobson’s choice in framing monetary policy in the context of slowing growth rate and ‘lingering inflation’ (I.10). Purely on semantic grounds, I would say that it was Catch-22 for the Bank.

A Hobson’s choice is no choice at all. On the other hand, a Catch-22 means ‘a no-win situation’ or ‘a double bind’ of any type.

Core Inflation

The RBI has discussed the concept of core inflation as used in the West. After its inappropriate use was pointed out over the years it has desisted from employing the expression and now uses the mouthful “non-food manufacturing inflation”. It is only a matter of time before it focuses attention on Consumer Price Index (CPI) instead of the Wholesale Price Index (WPI), as it is doing now, even though it does take into account other factors in determining policies.

The blame for much of the pressure on the RBI to reduce the interest rate has to be laid on its door because of its emphasis on WPI, which has seen a large fall in recent years — something that is irrelevant to the common man who pays Rs 4 for a banana or Rs 10 for a drumstick.

Offshore Banking

One area not covered in an otherwise comprehensive report is the status of offshore banking units set up in the Special Economic Zones in the country. It is about a decade since they were set up in a few places by some banks. But no data or information is available in the public domain on their operations.

Overseas banking units (OBUs) do serve a purpose but they can also be a source of leakage for monetary and exchange rate policies depending on the effectiveness of supervision. Considering the importance of the Non-Deliverable Forward Markets in Singapore, Hong Kong, the UK and the US and their impact on the rupee-dollar rate, the public needs to be assured that our OBUs are not participants in those markets.

It is time for the Bank to publish an article on the status of OBUs, reviewing the progress, the contributions they have made and the problems and difficulties encountered by them and the RBI in supervising their operations.

Further, do they compete with domestic banks in attracting NRI deposits since they do not have the restrictions faced by domestic units?

The Report refers to the Report of the Financial Sector Legislative Reform Commission and its feedback on the various recommendations made by it (not published so far). The Annual Report should have been the right place to incorporate the views of the Central Board on the important issues on which the Bank has differed from the Commission.

In the absence of such an input, observers have little option but to go by the inauthentic and sporadic reports in the press. The setting up of an independent public debt office outside the RBI, recommended by the Commission, is an important issue facing the central bank.

At present, the RBI carries out what it calls “Open Market Operation” (OMO) by way of buybacks of securities, which I have called “Debt Management Operation” (DMO). It monetises fiscal deficit retroactively. DMOs address a fiscal objective — of helping the government borrow by bringing down yields. Will the debt buybacks stop once the independent debt office is set up — leading to a hardening of the rates, which may be in line with monetary policy under certain circumstances?

If not, what is the purpose served by the Office, which is supposed to free the RBI from the conflict of interest arising from its dual role as a monetary authority and banker to government? The Annual Report could have issued a veiled advisory to the government of RBI’s inability to continue with the buybacks, after the proposed office is established.

Savings and Investment

The Report says: “Amid high inflation, the problem of the falling savings rate due to low or negative real returns and disintermediation emerged as an important contributor to growing macro-economic imbalances in the Indian economy.” (II.1.5)

Saving is a function of income, not interest or yield on investment. Did not people save over the millennia when there were no institutions like banks?

While total savings are determined by income levels, their allocation among different channels of investment depends on the relative yields. The explanation in the Report applies to financial savings and not to total savings.

Rightly, there is considerable emphasis on investment as an engine of economic growth. But long-gestation infrastructural projects estimated to cost a trillion dollars will yield benefits over a long time.

For immediate growth the government should undertake quick-yielding projects, especially in the agricultural sector, and remove supply constraints for inputs.

(The author is a Mumbai-based economic consultant.)

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