The realpolitik of RBI

The decision of the Reserve Bank of India (RBI) to reduce the cash reserve ratio (CRR) is a recognition of realpolitik.

One would have thought that its interpretation of the economic situation in the two documents related to the policy review made out a case for maintaining the status quo.

The RBI is always under pressure before every review for liberalising its stance, something it could resist in the past, citing the continued trend of inflation over several months and the absence of economic reforms.

It could take the correct stand that there should be a burden-sharing by the Government.

Now, the Government claims to have done its duty with a host of reforms and has expected the central bank to keep its word and do its bit.

A strange mixture

Decrease in the projection of GDP growth rate, rise in expected inflation from the earlier estimate and cut in CRR, that form part of the latest policy announcement, constitute a strange concoction that does not jell together.

In its projections, the RBI should say whether they relate to the pre- or post-policy position.

Contrary to what it says, there is a surfeit of liquidity. (“Inflation: Visible and invisible”, Business Line , October 25)

In the quarterly review of developments, the RBI stated that:

Active liquidity management has kept liquidity largely in line with policy objective, balancing inflation concerns and the need to ensure credit supply to support growth;

The current credit slowdown largely indicates tepid demand conditions and distinctively lower credit expansion by public sector and foreign banks, partly reflecting their risk aversion; and

Deteriorating asset quality may have affected credit expansion.

One wonders how the CRR cut is going to change the situation. The bank’s justification is to pre-empt a likely liquidity constraint in the coming days.

The injection or withdrawal of liquidity can be done in one day. There is no need for any action in advance by several weeks.

In any case, an injection of Rs 17,500 crore is a drop in the ocean of money supply and liquidity. One may expect a further increase in excess SLR investments of banks.

The reforms

But what are the reforms that the Government has ushered in so far and how much would they raise the GDP now or later?

The ‘reforms’ could be derailed in Parliament by the Opposition, aided by the allies of UPA.

But, today, the Government’s credibility is at such a low ebb that no one believes in its road map for fiscal correction, announced by the Finance Minister a day in advance of the RBI policy review.

Only five months are left for the completion of the current fiscal year.

The current trends in fiscal deficit are such that it will be very difficult to contain it within the target, unless the expectations are realised in respect of disinvestment and telecom spectrum fee.

A difficult future

Hard days are ahead for the central bank on both the home and external fronts. While it has some instruments that it can deploy with limited success on the domestic side, the problems on the external sector are more difficult because of the exogenous factors. The Finance Minister said: “Government is confident that the CAD will be fully financed by capital inflows, and expects that a substantial part of it will be in the form of Foreign Direct Investments (FDI), Foreign Institutional Investment (FII) and External Commercial Borrowings (ECBs).”

The country is already facing a near-critical situation with the crucial, among the vulnerability indicators on external debt worsening in the recent period. ECBs could be discouraged if our banks extend forex loans on international terms assisted by a refinancing window at the central bank.

While FDI is welcome on the reasoning that it will be here to stay for a long time, it also comes with a cost. The amounts of income on equity and investment fund shares (or dividends on FDI) remitted abroad were $3.3 billion, $3.1 billion and $2.6 billion in April-June 2011, January-March 2012 and April-June 2012, respectively. With increasing FDI, the outflows may rise over a period of time bringing to bear another type of pressure on the current account in the future.

A shift in focus

Under the circumstances, the focus should shift to mobilising the enormous wealth of non-resident Indians through bank deposits.

The debt owed to them is on a footing different from that owed to others. There is a need to free the forex-denominated FCNR (B) deposits from interest rate regulation.

On forex interventions, the RBI should be a little more innovative, taking a holistic view of its open market operations. Whenever there are signs of rupee appreciation, it should buy dollars unobtrusively and build up reserves.

In fact, ceteris paribus , if there is a liquidity shortage, it is better to purchase dollars, infusing rupees into the system than buy back securities. In the former case, it is acquiring real resources, in the later only IOUs. The amounts may be small at $100-$200 million on each occasion but, over time, the RBI can hope to enhance the level of its foreign currency assets to $300 billion from $260 billion now. This is the legacy that the Governor may try to leave behind before he completes his term at the RBI.

(The author is an economic consultant.)

COMMENT NOW