MAVERICK VIEW. Miles of smiles but problems await

Governor Raghuram Rajan’s fourth bi-monthly monetary policy for 2015-16 on September 29 predictably evoked miles and miles of smiles in government and industry for the reduction in the policy repo rate from 7.25 per cent to 6.75 per cent but, in the ensuing period, life for the Reserve Bank of India (RBI) could turn difficult for reasons beyond its control.

Ideally, governments should leave monetary policy to the central bank but unfortunately governments the world over, in recent years, have felt it to be their bounden duty to be overbearing on central banks.

In India, the government and the RBI have all along had extensive dialogues on monetary policy but this was within closed doors and the top honchos in the government did not make any public pronouncements prior to the policy.

In the last ten years, however, finance ministers and top government officials have routinely indicated, publicly, what the stance of the monetary policy ought to be. In effect, even the fig leaf of autonomy has been torn to shreds.

To make matters worse, the government talks about the granting of autonomy and the related issue of accountability of regulators. This works well for the government. When the going gets good the government takes credit and when things go awry the flag of autonomy is raised.

In the run-up to the policy of September 29, government officials and ministers had unequivocally indicated their preference for lower policy interest rates, but at the same time indicated that this was quite properly for the RBI to decide. The coup de grace was Finance Minister Arun Jaitley’s remark on the eve of the policy that common sense points to the need to reduce interest rates.

While as a columnist I had clearly indicated my preference that policy interest rates should not be lowered, I certainly would not go along with the critics of the RBI that “the RBI has buckled under”. Having some knowledge, albeit of a couple of decades ago, of how the RBI undertakes its work on monetary policy, and being aware of the RBI’s superior knowledge and renowned analytical skills, I would respect the RBI’s judgment.

My underlying concern, however, is that continuing reductions in interest rates would adversely affect financial savings and ultimately affect the growth of the economy.

We live in a global environment where governments have gone haywire in pressing for soft monetary policies which have failed to revive global growth. We now have articulation in the UK that it is time to think of negative interest rates!

There is considerable advocacy in India about low interest rates generating a virtuous cycle of growth. Let us assume that interest rates are lowered by 5 percentage points; if an industry has interest cost amounting to 20 per cent of total costs, the reduction in cost of production would be only one percentage point. Thus, the problems of industry are erroneously focused on interest rates.

We need to pause and think about the response of bank depositors. At some point of time, depositors would shift to non-financial assets. Admittedly, lowering interest rates would not alter the level of deposits but would drastically alter the composition of deposits. Depositors would reduce their term deposits which will aggravate the asset-liability maturity mismatches of banks which will ultimately impinge on borrowers, particularly large industry.

The September 29 policy document also covers a number of important regulatory issues and while all these issues cannot be covered in this column, a reference to some of them would be apposite.

(i) While there are elaborate regulatory norms relating to income recognition, asset classification and provisioning, in many cases there are divergences between banks and the supervisor. Where the divergences exceed a specified threshold, the RBI will mandate disclosures in the Notes to Accounts. This is a salutary measure. Moreover, when a bank is under Prompt Corrective Action, this should be required to be prominently displayed in the bank’s balance sheet.

(ii) Banks are permitted to hold investments, for valuation purposes, under the Held To Maturity ( HTM) category in excess of the limit of 25 per cent of their total investments, provided the excess comprises only Statutory Liquidity Ratio (SLR) securities and the total SLR securities held under the HTM category are not more than 22 per cent of the Net Demand and Time Liabilities (NDTL). Since the SLR prescription has been brought down to 21.5 per cent of NDTL, the ceiling on SLR securities under HTM is being brought down to 21.5 per cent. A further significant measure is that both the SLR and the HTM ceiling will be brought down by 0.25 percentage point every quarter till March 31, 2017. Conceding of the HTM concession was itself a wrong measure which was granted many years ago. In the mid-1990s the RBI had been on course to move, in stages, to a 100 per cent marked to market valuation and the substantial concession on HTM was a misadventure. More importantly, the phased reduction in the SLR prescription is an important measure and the government needs to take this into account while framing the borrowing programme.

(iii) The measure to increase, in phases, the foreign portfolio investors’ ( FPI) limit in central government securities to 5 per cent of outstanding stock by March 2018 is a salutary measure which was recommended to the RBI a decade ago.

(iv) The permitting of rupee bonds raised abroad by corporates is welcome but this is also a measure that was recommended many years ago.

The writer is a Mumbai-based economist

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