Which way will RBI go? Financial Express 11th September 2010

Having more formal monetary reviews and possible announcements is just what is required to keep the hype alive on monetary policy. The market is always trying to guess what RBI is going to do between policies, and RBI has decided to have more policies between the four policies to remove uncertainty. However, this has still not stopped the media from ‘asking’ between these new policies whether RBI is up to something. One can guess that the media and markets will always be trying to out-guess what RBI will do. More policies may not really reduce the level of speculation.

The question being raised again is whether or not RBI will increase rates, now that inflation and growth show different tendencies. Inflation appears to be coming down, although admittedly, it is a mirage. The growth perspective is fogged by the June IIP numbers. So there may be a case to legitimately ask for a guess on the rates issue.

Now, when RBI comes up with the next policy later this month, there are certain issues that should be addressed so that it becomes more than a stance on rates. Monetary statements are normally cloaked with conservative statements of a number for GDP and some words on the downside risks, which is inflation today. But, it would be useful if RBI can actually throw some light on certain pressing issues.

The first is, why are deposits not increasing at a steady rate? There are explanations being given in terms of households moving to capital markets or corporates withdrawing their deposits or banks not raising wholesale deposits as there is not much demand. We really need to know the ‘why’ of it since interest rates have been increased several times this calendar year and if savings are sensitive to interest rates, they should be going up.

The second pertains to credit. There are conflicting views on growth in credit. We all know that the 3G auctions necessitated a large demand for credit. But this credit is analogous to unproductive expenditure as the money is being transferred to the government through borrowings that will go into consumption. Hence, it is not reflective of what kind of investment is taking place in the economy. Then there is the question of whether there is less demand for credit or whether the cost is keeping firms away. Any which way, RBI can ask banks to provide an explanation that can be put forth this time so that we get the true picture.

The third pertains to the question of industrial growth. The June numbers show that there was a slowdown and that the base year effect would percolate for some time. The July numbers for infrastructure industries are abysmal. So what is the true picture like on industry? RBI usually presents the CSO picture on industry and does not really give its own view. By providing an independent perspective there would be some value addition on the subject of state of industry and growth.

Can RBI have anything new to add? The answer is yes, if it wants to, as there is one issue of monetary management that has to be resolved. RBI, for example, has raised interest rates in a bid to make funds expensive. In a deregulated set-up, the banks do not have to follow RBI and can take an independent decision. Now, in the last two policies when RBI increased rates, some of the top bankers had officially responded by saying that they would not be increasing rates. This raises a dilemma for RBI. If banks are openly going to say that they will not follow suit, then the idea of announcing rate hikes gets diluted. While it is good from the point of view of the working of banks, it is not so from the point of view of policy. How does one get over this one?

Today, RBI controls the repo and reverse repo rates and works on the premise that these rates get translated into other bank rates. With there being no limits to these auctions, banks actually can invest at 4.5% and get funds at 5.75%. If RBI instead brings in a quantitative limit on the same, then it would actually jack up the rates in the money market and banks would be compelled to follow suit. While quantitative restrictions are actually not an efficient system, in the given case, RBI should think of bringing this back as it was earlier. This is one way of ensuring that the rates do rise when we are in the repo mode of operation in the market.

Getting in some of these possibilities will most certainly add a breath of fresh air to the policy.