S S Tarapore

Worrying trends in monetary policy

Updated on: Aug 09, 2012
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India should not be aping monetary policies of the West, as the situation here is very different. If the RBI does lower interest rates, it would impact domestic savings.

The Reserve Bank of India (RBI) deserves kudos for setting out the rationale of its monetary policy of July 31 with painstaking effort.

The global situation is increasingly worrisome. Despite all the international confabulations, the world economy has not come out of the quagmire. Never before have central banks, the world over, resorted to such unbridled money creation. The stage is now set for the global storm of 2013.

We in India need to quickly put up the storm shutters. With totally ineffective macroeconomic policies in the major industrial countries, a worsening of the global economic crisis appears inevitable.

Although our growth rate of around 6 per cent puts us among countries with high growth rates, our macho spirits are not content, and there are clarion calls for a faster rate of growth which, in the context of the possible global storm, could recoil on us.


The fisc is totally out of control and we take comfort in the fact that our debt-GDP ratio, though high, is lower than for a number of countries.

What we need to recognise is that India has a high-growth, high-inflation environment, while industrial countries face a low-growth, low-inflation scenario. Thus, aping the industrial countries’ monetary fiscal policies could be disastrous for India.

The Macroeconomic Review makes a telling comparison of global inflation indicators. India has the highest policy interest rate (8 per cent) and the highest consumer price index (CPI) inflation rate (10.25 per cent), resulting in a negative real interest rate of 2.5 per cent.

Despite strong assurances and determined body language that hard policy options would be taken, political economy imperatives do not give credence to such intentions.

India Inc has expressed disappointment at there being no relenting in the July 31 policy on the cash reserve ratio (CRR) or policy interest rates.

The RBI has done well to withstand pressures from the government and India Inc. It is preferable that the RBI be criticised today but vindicated in history.

Thus, the central bank should not relent on monetary policy until the CPI comes down to the RBI’s 5 per cent comfort zone. Too early an easing of monetary policy would only result in a resurgence of inflation.


In its July 31 policy, the RBI reduced the statutory liquidity ratio (SLR) from 24 per cent to 23 per cent of net demand and time liabilities.

While this reduction is equivalent to Rs 62,000 crore, it is not as though there has been an injection of Rs 62,000 crore of primary liquidity. At present, the average holding of SLR securities by the banking system is close to 30 per cent of liabilities.

As such, the SLR stipulation was no constraint to borrowing from the RBI under the repo facility. There are, however, a few banks, mainly foreign banks and some private banks, whose holdings of securities are close to 24 per cent.

These banks would have been required to approach the RBI for accommodation without collateral of securities at a higher rate of interest; these are the banks which will benefit from this measure.

A quick glance at the participants at the RBI post-policy conference of August 1, 2012 reflects a powerhouse at work — of foreign bank analysts. The abstruse discussion on liquidity, yields, etc, merely obfuscates the fact that the major beneficiaries of SLR reduction are the foreign banks.


A simple analysis of the inter-linkages between savings, investments and the balance of payments’ current account deficit (CAD) shows that the predominant component of savings is domestic savings. There is disproportionate policy focus on foreign capital inflows.

Harish Damodaran, in his seminal article ‘When animal spirits reigned’ ( Business Line , July 31), argues that the India Growth Story of the 2000s was fuelled essentially by domestic and not foreign capital.

While the objective at the present time is to stimulate domestic savings, there is a great divide between precept and practice.

There is a powerful lobby which sees lower interest rates as a panacea for stimulating growth.

One does not know what to make of the Guidance in the RBI Policy Statement of July 31, 2012 (Page 11 Paragraph 50) wherein it is stated that “ ... monetary action over the past two years may have contributed to the growth slowdown ...”

A best-case scenario is that the statement by the RBI is a Galileo-type recantation; but if this is the new received doctrine of the RBI it portends severe difficulties for the saver.

The big worry for central banks the world over is the emergence of the view that working the printing press on an overtime basis does not pose a danger of inflation.

If this view continues to prevail, the world is headed to a hair-raising inflationary explosion a la the inter-war years of the 1920s. Total insanity would prevail.

As Friedrich Nietzsche said “Insanity in individuals is something rare — but in groups, parties, nations and epochs it is the rule”.

(The author is an economist. >blfeedback@thehindu.co.in )

Published on November 16, 2017

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