Did the government achieve anything substantial through its rapid fire announcements involving liquidity stimulus and so on?
Developments over the past two weeks leading up to the mid-term review of the credit policy by the Reserve Bank of India on October 24 show how important a properly articulated communication strategy is in allaying major concerns such as those that have arisen in the wake of the global financial crisis.
India and China, considered more resilient than most other countries, have been affected in various degrees. Policymakers in all countries have been announcing a slew of measures to combat or proactively thwart the contagion. Everywhere the emphasis is on financial stability.
The spillover effects of the crisis on the real economy should be minimised. Central banks are willing to go the extra mile in keeping the frozen credit markets open.
In India, the sweeping monetary measures involving a massive reduction in the cash reserve ratio (by 250 points) and a one percentage point repo rate cut — announced just four days before the mid-year review — were the most visible part of a package to boost liquidity. Many of these proposals — announced in rapid succession — showed the government to be ready to meet any unforeseen challenge.
However, judging by stock market behaviour, the goal of stabilising the financial sector has proved elusive. The day the credit policy was announced the Sensex and the Nifty crashed.
Although it is part of a global collapse certain inferences unique to India can be drawn.There are a few important issues that need to be analysed.
The government was neither wanting nor meagre in its responses. But, even granted that the market sentiment is notoriously fickle, did the government achieve anything substantial through its rapid fire announcements involving liquidity stimulus and so on?
Second, inasmuch as the credit policy was scheduled for end October, would it not have been better to defer the most significant measure — the repo rate cut — to October 24, the policy date?
Lesser role for RBI?
This brings us to the larger question as to who really has been in charge. Did the RBI have to follow the script laid down by the Finance Minister even if it was in broad agreement with the government on how to handle the crisis?
Given that the crisis was assuming menacing proportions abroad and its effects on the Indian economy were becoming apparent by the day, should not the Prime Minister have made a statement earlier than he did?
Answers to all these questions are relevant to understanding the credit policy that was reviewed on Friday. Making a suo motu statement in Parliament recently on the global financial crisis, Prime Minister Manmohan Singh said that banks in India were safe and that depositors need not worry about the safety of their money.
However, in an indirect way, the broader economy would be affected leading to slower growth. The Government would try to minimise the deleterious consequences of the global financial crisis, he added.
The Prime Minister’s statement, though not original, was overdue. Ever since the financial crisis erupted on the global stage in August 2007 political leaders and central bank governors in nearly all countries have been reassuring markets and investors even as they announced sweeping measures aimed at stabilising the markets.
In India that role has been assumed by Finance Minister P. Chidambaram. He has performed the role with aplomb but it was felt that his ministry was taking on a larger role, usurping some of RBI’s functions.
Monitoring and making statements on domestic liquidity, for instance, ought to have remained within the domain of the central bank, not the Finance Ministry. A massive repo rate cut by 100 basis points just four days before the mid-year review of the credit policy may at one level indicate a sense of urgency to do something. But it gives very little room for the RBI to do a repeat act in such a short time.
Communicating with the markets is a job that central banks the world over are learning to be increasingly adept at. As a rule they enjoy greater credibility than politicians.
One wishes that the new RBI Governor, himself the Finance Secretary until recently, had a larger role in articulating the official stand on the financial crisis prior to the credit policy.
There would have been at least two to three salutary messages. It would have shown the RBI continuing to be firmly in charge of monetary policy. A central bank reasonably independent of the government and co-ordinating official responses to the crisis would have sent the right signals.
Two, for political leaders, however savvy, in the present crisis stricken environment, it is a high risk gamble to take charge of a ‘rescue’ effort. In any case there is still plenty to be learnt about the turmoil by everyone, everywhere.
Three, the most defining characteristic of the financial sector crisis has been the panic. It was panic that felled once mighty institutions like Lehman Brothers. It has been panic that has been driving down stock markets everywhere. In India, the Sensex went below 10000 and on October 24 to below 9000.
It is panic again that put paid to western governments’ hopes of stabilising the system quickly even after they announced huge bail outs and dramatically shifted their traditional ideological stance towards markets. It is panic that has led to extreme risk aversion in the financial markets. But panic is rooted in psychology and is less likely to be contained by apparently logical assurances and actions on sound regulation, adequate liquidity and so on.
Four, for all its seriousness, the financial sector crisis alone cannot dominate monetary policy even over the short-term. Inflation, hovering above 11 per cent, can never be wished away. Nor could concerns over the economic slowdown.
Finally, one wonders whether the flurry of measures orchestrated by the Finance Ministry ahead of the credit policy raised extraordinary and unrealistic expectations from the credit policy statement leading to widespread disappointment _ and stock market losses _ when no ‘spectacular’ measures were announced.C.R.L. NARASIMHAN