A superb juggler’s act

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Sounding the right notes of caution.
Sounding the right notes of caution.

The RBI Governor, Dr D. Subbarao, has done a fine balancing act in the backdrop of an expansionist Budget, excessive liquidity and subdued credit expansion. With inflation very much alive, domestic savings must be encouraged to facilitate investment and growth, says S. S, TARAPORE.

The Reserve Bank of India (RBI) Governor, Dr D. Subbarao, had to craft the July 28, 2009 Monetary Policy Review under very difficult circumstances. From September 2008, his task had been relatively easy as all he had to do was to loosen the monetary policy levers. A few months ago, Governor Subbarao candidly admitted that the real music would start when there would be a need to reverse gears.

The backdrop to the July 2009 policy was the brazenly expansionist Union Budget for 2009-10; to top this, on July 27, on the eve of the Monetary Policy Review, the Finance Minister distributed further goodies. In such a milieu, Dr Subbarao deserves full credit for a policy which sounds all the right cautions on the hurdles ahead. This is done with élan and style. The short and crisp, yet relevant, policy document bears the unmistakable stamp of Dr Subbarao.

Signal service

Without debunking the dangerous idea currently popular with the government, the industry and a number of economists, that inflation has been slain, the Governor has provided signal service by emphasising that the negative Wholesale Price Index (WPI) is largely a statistical effect of the higher base of last year and that it should not be interpreted as a structural deflation arising out of a demand contraction.

With telling effect, he sets out a table (Page 8 of the Policy Document) to show that, even according to the WPI, food and other essential commodities show uncomfortably elevated price increases. What is more, the Consumer Price Indices (CPIs), on a year-on-year basis, range between 8.63 per cent and 11.52 per cent. In other words, inflation is not extinct.

The expansion of M3, on a year-on-year basis, as of July 3 at 20per cent is slightly lower than in the previous year ( 21.1 per cent), but the current year’s expansion is well above the projection of 17 per cent for 2009-10. Despite ample liquidity and lower lending rates, credit expansion is subdued.

Subdued credit demand

This indicates that the relative slowdown in the real growth rate has impacted credit demand. Hence, excessive pressures to increase credit and lower interest rates are unwarranted. The Policy Document does well to reveal that ample liquidity has generated competitive pressures on banks to lend at sub-BPLR rates. It makes the telling point that as a result of these distortions, in many cases, the BPLR has become the maximum lending rate.

The Deepak Mohanty Working Group would do well to restore the BPLR to what it is meant to be i.e. the lowest rate at which a bank is prepared to lend. The Working Group should not succumb to the pressures of vested interests pleading for the continuation of the sub-BPLR lending system. Yielding to such pressures would only buy more trouble for the RBI.

While the RBI has done well to stress the need to improve the monetary transmission process, it must focus greater attention to the depositors’ interest. At the present time, there is a real danger of depositors being sacrificed at the altar of avaricious borrowers.

As regards the stance of monetary policy, the RBI has projected the growth in 2009-10 at 6 per cent with an upward bias. The RBI recognises that a return to the earlier growth path of 8.5-9 per cent would be contingent on a strong global recovery.

As regards inflation, the RBI is, quite correctly, not swayed by the present negative rate of inflation and it does well to stress that commodity prices have surged ahead of the global recovery. The RBI expects the WPI inflation to creep up after October 2009 and has, therefore, raised its projection of inflation for March 2010 from the earlier 4 per cent to 5 per cent. As M3 expansion is running above the trend line of 17 per cent for 2009-10, the RBI has raised the projection to 18 per cent.

The Policy acknowledges that the current projections for both real growth as well as inflation can turn out to be higher. It is rightly stressed that India is not a demand-constrained economy, but a supply-constrained one and, therefore, the critical requirement is for increased investment, particularly in infrastructure. It hardly needs to be stressed that this entails emphasis on providing strong incentives to savers rather than the disincentives provided in the recent period.

The RBI has recognised that it needs to manage multiple compulsions — providing ample liquidity, facilitating the massive borrowing programme, providing adequate credit to the commercial sector and controlling inflationary pressures.

As the RBI points out, no country can sustain a high growth rate without an increase in investment and improved productivity. This will, no doubt, require financial sector reforms with emphasis on financial inclusion and development of financial markets. Above all this is the overriding need to encourage domestic savings and savers should not be treated like poor relatives who have nowhere to go.

Excess liquidity

The RBI has resisted the cheer squads on the sidelines urging lower interest rates and lower reserve requirements. The Policy makes the telling point that the release of primary liquidity since mid-September 2009 amounted to a staggering Rs 561,700 crore, equivalent to a 14-per cent reduction in reserve requirement (a further Rs 40,000 crore is released through a SLR reduction).

Such a large increase in liquidity cannot be justified on any ground. It is necessary that the RBI undertakes a smooth withdrawal of the excess liquidity in the system and the sooner the RBI starts reducing monetary accommodation, the better.

In a difficult situation, Governor Subbarao has done well not to listen to the thoughtless expansionists. The RBI, in all probability, will need to take early measures to withdraw liquidity in a non-disruptive manner. As Dr Montek Singh Ahluwalia said, the art of monetary policy is to keep a number of balls in the air. Dr Subbarao deserves to be complimented for performing a juggler’s act to perfection.

Anecdotal information indicates that neither the WPI nor the CPI seems to capture the ground level prices of a number of commodities of daily mass consumption. This is a serious issue and cannot be wished away by brilliant intellectual obfuscation. The situation is explosive and needs the overriding attention of the authorities. This issue needs exclusive examination in a dedicated article.

(The author is an economist.

(This article was published in the Business Line print edition dated July 31, 2009)
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