Why RBI decided to go easy

A SESHAN | Updated on June 03, 2014

Let's waitWe need more signals LUCAS PHOTO/SHUTTERSTOCK.COM

It needs to know the fiscal deficit and growth projections of the government, before it can proceed further

The Reserve Bank of India’s second bimonthly monetary policy statement for 2014-15 does not really mark a break from the past. The bank has been somewhat constrained by the absence of the Union Budget for 2014-15.

The direction of fiscal consolidation and the Government’s view of likely developments in the year would have been valuable inputs for the formulation of monetary policy. As a result, there has been no annual credit/monetary policy announcement for 2014-15 so far. We can expect the next review, scheduled for August 5, to benefit from the presentation of the Budget.

We may also hope that the final views of the Government and the RBI on the recommendations of the Urjit Patel Committee would be available by then. The RBI has taken note — to the extent possible — of the committee’s suggestions. One instance is the switchover to Consumer Price Index (CPI) from Wholesale Price Index (WPI) in its assessment of inflation. WPI is conspicuous by its absence.

Reassure economic agents

This writer has argued that the Central bank should avoid making any reference to its estimate of deposits, money supply and related aggregates in the forthcoming year. This suggestion seems to have been accepted since the last review.

Just a statement that no productive activity will suffer on account of lack of credit should be reassuring to economic agents. The only estimates in the RBI policy statement are on GDP in this year and inflation in January of 2015 and 2016.

It is difficult to see how anyone, even with the help of the most sophisticated econometric tools, could predict the course of prices a year or two from now, given the imponderables. The damage is that such estimates lose credibility with the public when proved wrong.

All econometric forecasts are conditional. They hold good or become valid if the underlying assumptions turn out to be correct. It will be helpful if the RBI could throw more light on the model underlying its predictions either on GDP or inflation.

Both, the demand and supply of goods and services are driving the inflation rate. The so-called supply constraint is a false reason in view of the bulging stocks of foodgrains. The rise in prices of vegetables, fruits, milk, eggs and so is attributable to the pumping of money in rural areas under various schemes that are mostly in the nature of doles with no substantial impact on output. This is borne out by the high inflation rates for food products in rural areas which are the sources of supply. This rural inflation spills over to the urban areas.

Watch out

The reduction in statutory liquidity ratio (SLR) by 50 basis points should be welcome to banks. They have more funds to give as credit to the private sector. In the first place, the Government’s need for funds will not diminish in the coming year. The reported achievement in attaining the fiscal deficit target for 2013-14 has been attributed by knowledgeable observers to the withholding of subsidies for payment in the next fiscal.

An amount of ₹1 lakh crore has been mentioned in this connection. But there are other arrears pending, such as the outstanding bills of suppliers/contractors, income tax refunds, and so on.

Unfortunately, the transition to accrual accounting from cash accounting is yet to be completed. The budget document should provide data, suitably classified, on all the amounts outstanding as arrears so that one can judge the extent to which fiscal consolidation has been achieved.

In the context of the Five-Year Plan, capital spending has to increase in the current year and the future to compensate for the cuts made last year. The reduction in SLR would mean that the Government will have to compete with other sectors more vigorously to raise funds, leading to rises in interest rates.

Secondly, banks have often invested more than the statutory minimum in gilts because demand from the private sector was not forthcoming.

As on May 16, 2014, banks’ investments in gilts amounted to 29.3 per cent of their deposit liabilities against the statutory minimum of 23 per cent. Thus the level of SLR is not a binding factor in the issue of credit to the private sector. Of course, even in the changed situation nothing prevents the banks from investing in surplus securities, especially when the non-performing assets are on the rise and banks are looking for safe avenues of investment.

This phenomenon was once called ‘lazy banking’ by a deputy governor of the RBI. It remains to be seen how the SLR cut will impact fiscal consolidation.

The writer is a Mumbai-based economic consultant

Published on June 03, 2014

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