The RBI tweaks it right

The option of living with inflation is no longer seen as an option.

RBI Annual Report 1981-82

The Reserve Bank of India should be congratulated for coming out with a realistic policy review supported by a document that leaves no illusion in the minds of the readers as to the state of the economy.

It has brought down the estimate of the growth rate of the economy to 5.0 per cent and raised the projected consumer inflation to 9 per cent.

That these adverse developments in the economy are acknowledged a few weeks before crucial elections to five State legislative assemblies is evidence enough of its apolitical stance in matters relating to the economic fortunes of the country. It has tweaked the policy rates appropriately, keeping in view the liquidity and price situation.

However, if the repo rate is raised to lower inflationary expectations, why should RBI provide additional liquidity through term repos costing less than the MSF in the auctions thus creating an inverted yield curve?

Rather than essentially helping banks short on liquidity, it enables banks with surplus SLR investment to roll over their borrowings on a term basis also in addition to doing it daily, perhaps to play in the money market. Is there a need for term repos when the daily ones could be rolled over from day to day indefinitely?

For the first time, the year-end expected inflation for consumer prices is indicated instead of the wholesale price index. It is a subtle shift in the basis for assessing inflation for formulating a policy response.

The increase in repo rate reinforces the strong stand taken by the Governor on the occasion of his first press meet when he referred to the mandate of ‘monetary stability’ in the Preamble to the RBI Act.

INFLATION TOLERANCE

One only hopes that, in course of time, he will shed the past baggage of the concept of ‘acceptable’ or ‘tolerable’ inflation in formulating monetary policy.

While no one expects a zero rate of inflation in a growing economy with ambitious Five-Year Plans it is unfair to the poor people to face a price rise of 5 per cent year after year with their incomes stagnant or even falling. The very mention of 5 per cent as acceptable to the authorities raises inflationary expectations because the common man knows from his past experience that it will be exceeded.

The RBI declaration cited at the beginning of the article sounds heroic at this point of time. It belonged to another age when none in the Bank or government talked of an acceptable inflation rate.

I would differ on the Bank’s somewhat optimistic outlook on the external front. The inter- and intra-day variations in the exchange rate are now less volatile than in the past.

It has been achieved thanks to innovative policies like the swap arrangements with oil marketing companies and commercial banks and the relaxation of the interest rate structure of non-resident deposits.

Even though the successor to Ben Bernanke may pursue the policy of quantitative expansion (QE) for some time, it cannot continue forever. India needs to be prepared for QE’s eventual tapering with a consequential damage. I would strongly urge the RBI to aim at an informal target of Foreign Currency Assets (FCA) of $300 billion in its kitty by the end of the financial year.

AUGMENTING RESERVES

Considering the FCA $253 billion in total reserves of $281 billion, as on October 18, 2013, it would mean accumulating forex of around $50 billion in about 20 weeks.

It is not impossible, considering the encouraging results of swap arrangement in the short period since it was launched.

To augment the reserves I would suggest first the termination of the swap arrangement with oil marketing companies by the end of November or, at the latest, December. Secondly, there is good scope to remove the remaining restrictions on the Foreign Currency Non-Resident Deposits.

The banks may be relied upon to exercise their discretion appropriately in fixing the rates. The swap arrangement is now limited to FCNR deposits of three years and above, it should be extended to one- and two-year deposits as well. The penalty prescribed by banks is sufficient to discourage depositors from the premature withdrawal of funds.

The RBI should not be overly influenced by memories of the Gulf Crisis when circumstances were completely different.

The country is in a much stronger position. The drain of reserves is not likely to take place, going by the current trends in the balance of payments, the positive seasonal effect of the second half of the year on exports and the subdued imports of gold.

In any case, the RBI should refrain from engaging in Rambo-like interventions in the forex market. According to the Bank of International Settlements’ Triennial Central Bank Survey of Foreign Exchange and Derivatives Market 2013, the daily average turnover in the global markets was $5.3 trillion in April, of which one per cent (including non-deliverable forward markets) was accounted for by India.

The forex reserves are just equivalent to less than 6 days of market turnover.

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

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