The illusion of cheap money

Just before the Reserve Bank of India’s mid-quarter review of monetary policy, the State Bank of India Chairman Pratip Chaudhuri revived the argument that the central bank should pay interest on the cash reserve ratio (CRR). CRR is the mandatory deposits banks park with the RBI; funds that are, therefore, not available with banks for all practical purposes.

The SBI chief was raking up an old issue that had lain buried for a year to the day. Perhaps anticipating the RBI’s reticence on monetary easing, on cuts in repo rates or CRR holdings, Chaudhuri had dusted the file on CRR off his shelf to demand that the central bank pay Rs 500 crore interest on the bank’s interest-free mandatory deposits with the RBI holdings. He promised to “transmit” such an amount to borrowers.

Around the time of last June’s mid-quarter review, the SBI chief had created something of a minor storm when he complained about the extent of funds withheld by the RBI from the banking system’s circulation channel by way of CRR. The SBI chief’s reasoning turned into a spat with RBI Deputy Governor K. C. Chakrabarty, that was gleefully reported by the media. At one point, the RBI Governor stepped in, and, in his first public comment on the verbal fisticuff, bandied the idea of forming a committee of just the two duelists to sort out the matter — but not till he had demitted from office.

The spat over CRR would have ended, had not two key policymakers weighed in on the side of the SBI. Finance Minister P. Chidambaram thought the RBI should pay an interest of 7 per cent on such holdings, adding that the central bank should consider the CRR as one of several monetary tools for credit control in the pursuit of its anti-inflationary objectives. More obliquely, the chairman of the Prime Minister’s Economic Advisory Council C. Rangarajan added his own wisdom to the idea of the CRR as an outmoded weapon for monetary tightening, one that should be used, he advised, “in extraordinary circumstances.”

The public debate the SBI chief wished for did not really take off; the RBI stuck to its guns, modifying the CRR rate in the light of its take on the economy and inflation. Since January 2012, the RBI has lowered the CRR rate 125 basis points. So, by the standards of ‘financial suppression’ of yore, the RBI has been doing what its former Governor C. Rangarajan thinks it should be doing — lowering the proportion of statutory holdings as CRR. As part of that ‘financial suppression’, in 2007 it stopped paying interest on CRR.

Would interest on CRR help?

The RBI was of the view that paying 7 per cent on bank deposits with it would not help in the manner envisaged by the SBI chief, namely, in increasing the funds for lending. This was because banks had not transmitted whatever cuts in repo rates and CRR had taken place.

Behind that defence is the larger position that, at the end of the day, bank lending is not just a function of costs — important as they may be — but that of the general environment for growth. Banks do not turn the spigot of funds on the signal from a generous RBI. They also read the tea leaves of economic sentiment; if that is not conducive to growth, easing monetary policy or paying banks interest on their statutory deposits may not help. It could, however, stoke inflation. One need only look at the US where the Fed’s rounds of quantitative easing and the Board’s low interest rates have not helped revive investments domestically; emerging markets have benefited more with capital flows lubricating, sometimes far too much, the wheels of the financial markets. But in the US itself, jobs are still thin on the ground.

Cheap money power

Yet, the belief in the power of cheap money to spur growth does have many takers, not just on account of monetary economic theory, but also because of a subtle spin from both New Delhi and banks. The inability or unwillingness to get a handle on sustainable fiscal or public policy — be it the GST or better delivery mechanisms for infrastructure — forces policymakers to lean on the RBI, as if the only deterrent to growth was the central bank.

For banks, the fact that their money is lying idle in the RBI vaults — Rs 21.000 crore according to the SBI Chairman last year — the CRR comes as a good smokescreen to hide their risk aversion, justified as it may be in the present juncture. Which bank would like to admit that the scene out there is none too good; that they would rather leave their money in government securities than lend it out to clients, corporate or otherwise, that might add to their non-performing asset portfolio?

Chimera of freedom

Behind the demand for interest on CRR or its outmodedness in the present age is the impatience with statutory requirements and, more generally, with regulations that are viewed as inimical to business expansion. Numbers cast their own illusions: Rs. 21,000 crore locked up as CRR is a huge amount to be kept away from a public waiting for cheap funds.

But the lessons of 2008 and the greed of banks uncontrolled by regulation that could have reminded them of their fiduciary responsibilities can hardly be ignored by India. Perhaps, state-owned banks that make the demand for interest on CRR or the abolition of statutory deposits know well enough that the sovereign guarantee will always bail them out.

This assurance then makes it tempting for banks to play with the illusion of cheap money’s power to create the magic of growth; to allow the invisible hand of profit-making override their fiduciary role.

As the eventual guardian of public money, it’s comforting to know the RBI continues, at least for now, to stay that hand.

COMMENT NOW