RBI can still tighten the screws

It never rains but it pours! This is as true of the economic situation today as it is of the progress of the South-West Monsoon. Anaemic growth, worrisome twin deficits, negative export trends, intractable inflation, a declining rupee in the forex market — what more is required to keep the cup of woes full for the Reserve Bank of India (RBI) engaged in the review of Monetary Policy on July 30?

Impact of recent measures

The measures of the central bank announced on July 15 aimed at weakening the speculative elements in the forex market that utilised repo funds. It was a better strategy than direct intervention keeping in mind that forex reserves are hardly equivalent to five to six days’ turnover in the market. The measures have had greater impact in raising bond yields than loan rates for the following reasons. The banking system is holding surplus securities under Statutory Liquidity Ratio (SLR) that can be set against the legal requirement for some more time without further investments.

In fact, it is a buyers’ market for gilts as evident from the failures at the recent auctions of government paper. Apart from the additional interest burden on government the adverse side effect of a rise in security yields will be that they will be even more attractive than now resulting in a deceleration in the flow of credit to the non-food sector. The drawals from the repo window in the recent days have not reached the ceiling of Rs 75,000 crore. Call money rates have been below the repo rate. The special facility opened by RBI to help mutual funds has not been accessed. Banks, in general, have announced that there won’t be any hike in interest rates. This is understandable considering that they did not transmit the earlier relaxations in policy to their lending rates.

Thus, there is space for them to keep them at the current levels. There has been some decline in the daily volatility of exchange rates. What was then the need for the measures of July 23 restricting repo transactions further and the near-100-per-cent daily maintenance of the Cash Reserve Ratio? Perhaps the RBI found that there was still surplus liquidity in the system that could be deployed in the forex market.

There is a view that the July 30 review will be a non-event due to the recent policy announcements. However, there is scope for some fine tuning. Thus the interest rate on Marginal Standing Facility that has not been utilised except for small amounts may be reduced by 100 basis points to make life easier for banks that are hit hard.

Just as the July 15 measures tightened the policy without seeming so, now the central bank can appear to relax the measures though not in reality! RBI can also think of raising the SLR that would reduce the surplus securities in the system and the access to repos and provide price support to bonds.

Focus on CPI

After the criticism over the years of the inappropriate application of the Western concept of “core inflation” to India the RBI stopped referring to it from the Annual Review for 2013-14 onwards.

Instead, it now uses the more sober expression “manufactured non-food products inflation”.

It can walk the last mile by announcing the replacement of Wholesale Price Index (WPI) by Consumer Price Index (CPI) as its focus in formulating monetary policy.

It is logical and expected of the central bank to be concerned with the common man. It does not necessarily mean that it was wrong all along in its emphasis on WPI (“Monetary policy for the aam aadmi ”, Business Line , April 30).

If there is a new management in September (I hope not!), it is not likely to find fault with the shift in focus.

The RBI has indicated that it is willing to issue government bonds indexed to retail inflation in the next tranche.

The shift in emphasis on retail inflation will be a logical precursor to such bonds. It can, however, continue to include WPI in its multiple-indicator approach.

The demand and supply curves facing the wholesale markets, say, in food products, are different from those in the retail segment. Granger causality tests have not been conclusive in proving whether the transmission of price trends is from the wholesale to the retail markets or vice-versa.

The wholesaler aims at making money with small margins on a large turnover, the retailer at high margins on a small turnover. The former has the financial clout with his owned funds, bank credit and warehousing facility, including dehydration plants.

The average retail merchant has no meaningful storage capacity. Despite being in the priority sector he has to depend on private agencies to a large extent for credit on high interest rates.

That the middlemen in the marketing chain add to costs has been vividly brought out by the recent experience in Mumbai after the Government arranged to procure vegetables from the wholesalers and sell them through consumer cooperative stores.

The public could buy them at substantial discounts to the prices in the retail markets. The RBI critics should answer the question whether monetary policy can solve the institutional and structural rigidities behind the high retail inflation. However, excess liquidity can aggravate the situation.

That is where monetary policy comes in. The focus on CPI will be a lasting legacy of the Governor.

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

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