RBI broadly makes the right moves

On the basis of its review of current developments in the economy, the Reserve Bank of India (RBI) has reduced the policy repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis points from 6.75 per cent to 6.5 per cent; reduced the minimum daily maintenance of the cash reserve ratio (CRR) from 95 per cent of the requirement to 90 per cent with effect from the fortnight beginning April 16, 2016, while keeping the CRR unchanged at 4.0 per cent of net demand and time liabilities (NDTL); continued to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality; and narrowed the policy rate corridor by reducing the marginal standing facility (MSF) rate by 75 basis points and increasing the reverse repo rate by 25 basis points, with a view to ensuring finer alignment of the weighted average call rate (WACR) with the repo rate.

The RBI has taken advantage of a benign economic environment marked by subdued inflation, good growth prospects, and low fiscal and current account deficits. Its main concern is with the liquidity shortage in the economy. The average daily liquidity injection (including variable repos overnight and term repos) increased from ₹1,345 billion in January to ₹1,935 billion in March. Besides, durable liquidity was also provided through open market operations in February and March.

Liquidity shortage The liquidity shortage was caused by the heavy build up of the deposits of the Central government in the RBI amounting to ₹1 billion on March 27, 2016. An official of the Central government explained the situation by pointing out that it was usual for the Government to accumulate balances in March in preparation for debt redemptions in April.

But this is not a good explanation since public debt operations are mostly Ponzi games — replacing one maturing bond with a fresh one. Secondly, long back, I had suggested that the RBI, in consultation with the Government, could institute a system of auctioning surplus deposits among commercial banks, a system that prevails in some foreign countries. The advantages are two-fold.

On the plus side In the first place, the Government receives interest income unlike in the case of RBI deposits, which are interest-free. Secondly, the liquidity is not impounded and remains in the system.

There was an announcement that a committee had been appointed to look into the matter. But nothing has been heard of since then. My feeling is that the accumulation of government deposits was a cosmetic device to achieve the fiscal deficit for the last year. A true picture can emerge only if we have data on the outstanding liabilities of the Government in relation to unpaid bills, tax refunds, and so on. We have to wait for the cash accounting system to have a transparent picture of government finances. Though it has been talked about there has been no significant progress in the introduction of the system.

One fundamental issue that needs to be considered is whether, instead of the slew of measures, including reduction in the Statutory Liquidity Ratio, announced earlier by the RBI, a simple reduction in Cash Reserve Ratio could have achieved the purpose of relieving the system of liquidity shortage. Open Market Operations such as the buy-back of securities inject Central bank money into the system and monetise fiscal deficit retrospectively, whereas the CRR reduction only releases impounded money.

Borrowing costs There was a statement in the press conference after the release of the policy review that borrowing rates had come down significantly. One member of the management claimed that the lowering of the policy rate would make India a low-cost economy. This is debatable.

Interest costs constitute a small, perhaps negligible, proportion of total cost of production, according to company finance studies. On the other hand, a reduction in interest payments would make a significant contribution to the entrepreneur’s profit.

We have to do much more in R&D efforts than what been reported so far. We can learn a lesson from Japan in this connection. Japan faced a tremendous problem during the first oil crisis on account of the near-quadrupling of oil prices. But it engaged itself in massive R&D efforts to reduce dependence on oil. As a result, the amount of energy used for producing a tonne of steel was reduced by 50 per cent.

Similar was the case with the manufacture of consumer durables such as television sets, refrigerators, and so on. When the second oil crisis struck the world in the early 1980s, Japan was not much affected.

A matter of significance One significant achievement of India in R&D has been in the field of agriculture thanks to the high-yielding varieties programme. Yields of cereals went up but due to the government policy of increasing support prices for foodgrains for public procurement in every season to placate the vote-bank in the agricultural sector, the advantage of price reduction in agricultural products has not been achieved.

In my last review article, I pointed out the absence of detailed background information on the economy, as in the past, to see the policy measures in a proper perspective. The RBI appears to have appreciated the suggestion. There is a Monetary Policy Report accompanying the policy document.

The author is a Mumbai-based economic consultant

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