The Reserve Bank of India’s first quarter review of monetary policy unveiled on July 31 hardly caused any surprise with regard to interest rates. The reduction in the SLR — the percentage of deposits that banks are obligated to invest in government securities — by one percentage point to 23 per cent was the only monetary measure of substance. Meant to boost liquidity, it will improve the quality of monetary transmission. But, clearly, is not the RBI seized of the fact that government borrowings during the rest of the year are likely to be large and with the SLR reduction banks need to invest less in government securities? However, banks have been investing in SLR securities much more than what was mandated. So an enabling position that permits them to invest less in SLR from 24 per cent to 23 per cent may not be of much consequence to the overall conduct of monetary policy.
A one percentage point SLR cut theoretically releases Rs.62,000 crore. If the objective is to increase the quantum of funds for lending, the answer may not just lie in the SLR reduction or, for that matter. a cut in the CRR. Banks have been putting more money in SLR because it is considered safe, unlike commercial loans. This trend has been in evidence much earlier. “Play-safe” bankers have always sought the sanctuary of government securities rather than dispense commercial loans. The answer to this phenomenon lies not in dousing the system with liquidity (although that helps up to a point) but in taking steps to overcome “the fear psychosis” that has gripped not only banks but practically all decision makers in the government.
It is a welcome development that P. Chidambaram, who has been very clear-headed and articulate in approaching this problem in earlier spells, is back as the Finance Minister. The RBI will not explicitly state this nor would it find mention in the economic surveys of the government. Paralysis in public policy making is hardly a cliché, but a most serious problem waiting to be tackled.
The trade-off revisited
For the second time since June, the RBI has held on to the interest rates. There is, however, a significant difference to what the markets had expected in June and now. On the earlier occasion, the markets were convinced that a rate cut was a certainty. This time the fear of a resurgent inflation on top of high food prices was palpable. So, expectations of a rate cut were minimal. In April, the RBI had “front-loaded” interest rate cuts with a larger than expected 50 basis points (0.50 percentage point) in the repo rate. Its rationale, obviously, was to force the government’s hand to take appropriate fiscal measures, and support the monetary policy. Important measures that are expected from the government include, among other things, a cut in subsidies and economic reforms that would ease supply-side constraints. Such steps call for a strong political will as well as support from the UPA’s coalition partners. It is, therefore, highly unlikely that these would happen before 2014. So, the RBI’s wish-list is intended to highlight the crucial dependence of monetary policy on fiscal measures, and the central bank’s helplessness in the face of fiscal profligacy.
Perhaps the most important take-away from the first quarter review has been the RBI’s revised forecasts of gross domestic product (GDP) growth and inflation. The central bank expects inflation to be at 7 per cent by March 2013 higher than the 6.5 per cent forecast earlier. This reflects its concerns over inflation and inflation expectations. There are significant upside risks — deficient rainfall, high food prices, weaker rupee and suppressed inflation in fuel, electricity and coal. The GDP growth forecast for the current year (2012-13) has been brought down to 6.5 per cent from 7.3 per cent. As with inflation, growth projections are also subject to risks emanating from India and abroad.
Between the June policy statement and the most recent one (July 31), the Reserve Bank’s communication to the markets was of a high order. It managed to keep expectations of a rate cut in check by (a) focussing on recent inflation concerns, and (b) nuancing the age-old debate of growth versus price stability.
At a launch function of a book written by I. G. Patel, one of RBI’s foremost economic administrators as well as being one of his distinguished predecessors, Governor Subbarao forcefully defended the RBI’s recent monetary stance, focussed as it has been on inflation control. Dr. Patel Patel had said in one of his articles: “The supreme test of monetary policy lies in its ability to control the supply of money in such a way that growth is checked without retarding growth”. That, as Dr. Subbarao pointed out, was the quintessential growth versus inflation debate that was being played out even today. Knowledgeable commentators have interpreted to mean that monetary policy must emphasise price stability. In that case, growth concerns become a constraint.