RBI’S monetary actions are primarily focused on countering the rapid growth of foreign exchange reserves and all measures tantamount to controlling growth in commercial credit, which in turn has raised other issues on future growth. This approach is quite different from the earlier one where the RBI had to accommodate the flow of funds to the government, which at times could mean curbing the growth in commercial credit. Either way, monetary policy appears to be targeting growth in commercial credit to control inflation. It has been observed that at times when growth in credit is buoyant and the RBI is keen to lower the lending power of banks, it becomes essential to use direct controls on credit growth. This is also suggested by an analysis of the components of incremental money supply in the last seven years. The changing structure of the components of incremental money supply suggests five major trends. The first is that the share of the government has come down quite rapidly between FY02 and FY05. This has happened in two stages with RBI initially placing less of government paper with itself. In fact, it has reduced the intake of private placements along the way before eliminating them. After offloading these bonds to commercial banks through open market operations, the next step has been for banks to off-load these securities and lower their investment deposit ratio. This has been more prominent in the last two years, where banks were able to increase their lending to the commercial sector with credit growing by an average of 33% amidst monetary tightening by the RBI. The second trend is that forex assets have actively taken over from the government in terms of dominance in the last three years. The average growth of net forex assets of banks has been around 24%, comparable with the growth in bank credit. Thirdly, bank credit has grown rapidly in the last three years by an average of 31% which has pushed up the credit-deposit ratio to 74% from 53% at the beginning of the century. Banks have shuffled their investment portfolios to secure funds even as RBI has increased the CRR. This has been prompted by the high industrial growth rate during this period where companies have borrowed notwithstanding higher interest rates.
Fourthly, credit policy is now trying to counter the large inflows of forex assets which are responsible for the higher growth in money supply. The preference has been on using direct measures such as the CRR to interest rates. Monetary tightening had started from 2004-05 and the CRR has been raised from 4.75% to 6.5%. This has been more effective than the reverse repo rate, which also has been raised from 4.5% to 6%. But, in general it has been observed that the RBI has used the reverse repo or repo rate to signal its desired direction of movement in interest rates, while it has used the CRR to have a direct impact on money supply growth through pre-emption of resources. Higher interest rates do not really work to curb growth in credit at a time when the industrial sector is booming. More direct action is needed to sterilise inflows from the forex channel. Lastly, the component of non-monetary liabilities of the banking system is quite worrisome as it is a large amount which distorts the picture. By definition this reflects amounts that do not add to money supply and are in the nature of RBI deposits with international agencies such as the IMF, contribution to national funds and superannuation funds, paid up capital, reserves, and provisions of commercial banks and so on. However, as this number is also a balancing figure drawn by calculating the money supply through the deposits route and subtracting these sources of funding on the credit side, there is need to reconcile these numbers. This is more so because the share of this component is very high at times. Quite clearly, the message is that we need to have a policy of tackling external capital inflows directly as monetary policy has become fairly inhibitive in the last quarter or so... the room for manoeuvre has also narrowed down.
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