Liquid Enough: Financial Express: 28th January 2009

RBI’s credit policy is pragmatic even though it has done nothing. Perhaps, this is what Mint Street should be doing when all its policy measures fail to do what it wanted to achieve in the first place i.e. lower interest rates for borrowes. Lending rates haven’t fallen at nearly the same pace as the repo rate over the last few months. Still, RBI’s overall policy approach provokes some debate.
The first issue really is its stance on interest rates. RBI has been exhorting banks to lower interest rates which should, in a decentralised set up, be the prerogative of the banks. The fact that the public sector banks have responded more appropriately than the foreign and private banks does not speak of much autonomy for these banks.
Now, the ideological question is whether the regulator should be commenting on the direction of movement of the price which it regulates i.e. the interest rate here. Sebi does not tell NSE or BSE to keep share prices up nor does the FMC ask exchanges to ensure that prices move down. The price should be determined by the market, and while RBI can influence the supply of funds through the CRR and other infusions, it should desist from forcing banks to lower their rates. Banks have to take a commercial decision on rates, which should not be influenced unduly by RBI.
Secondly, for the first time, RBI has spoken of total funds available rather than just bank funds that are available to the commercial sector. The reason is that bank disbursements to the commercial sector have been higher than last year by nearly Rs 68,000 crore on an incremental basis. This means that credit is flowing to this sector contrary to the perception that banks are not lending money. In fact, the non-oil industrial credit was higher by around Rs 43,000 crore.
Flows such as FDI, capital markets, NBFCs and ECBs are lower with a decline of around Rs 83,000 crore. Evidently, the problem is more the lack of demand from industry rather than a problem of supply from banks. RBI, in the last 5 months, has infused around Rs 388,000 crore into the system but if supply isn’t the problem, then the additional liquidity would not have the necessary impact. RBI’s own survey has indicated, “weak demand conditions and decline in sentiment for production, order books, capacity utilisation and exports”. If this is indeed the case and there is a big demand squeeze taking place, then the question of supply and cost of credit are not that pertinent.
What about inflation? The RBI’s take on inflation is that it would be down to 3% by March-end. This number needs to be put in the right perspective. The RBI recognises that inflation by the CPI will be higher as consumer prices come down with a lag. It also acknowledges the base year effect on inflation, which is why a 3% number looks achievable. But, which inflation number should we look at? Ideally, what matters is the average inflation rate which is the rate calculated by dividing the sum of the 52 WPI indices for this year over that of last year. Now, if we assume that the rate would be 3% on a point-to-point basis for the next two months, and calculate this number, we still arrive at a figure of 8.4% for the year. Hence, the 3% number could be sending the wrong signals as it is affected by a high base number and ignores all that has happened during the year when purchasing power has been eroded.
The RBI has hence concluded that growth will be lower, but still impressive considering that we are going to do better than the rest of the world; inflation has been successfully controlled through monetary policy measures as well as softening of oil prices. While it has done nothing for the time being, it has assured us that it would make sure that funds would be available in the next two months, meaning thereby that more CRR and repo rates cuts are possible if warranted—especially if government borrowing will crowd out private demand for funds.