Rajan, a good balancer

In its first monetary policy statement on 3 June after the new government took office, the Reserve Bank could be said to have announced a ‘politically correct’ stance which accommodates the government’s concern for growth as well as the central bank’s concerns for inflation. The Reserve bank has introduced a more nuanced and accommodative credit policy following a review than seen recently. As a result, one can expect that the bitterness seen in the relations between the union finance ministry under the last incumbent 

P Chidambaram and Reserve Bank under its previous governor, Duvvuri Subbarao, should be a thing of the past. We can hope to see a more congenial atmosphere between the Reserve Bank and the union finance ministry. To recall that infamous confrontation, while finance minister Chidambaram had publicly asked for a cut in interest rates to aid growth, governor Subbarao responded by jacking up rates time and again to contain flaring prices. Giving away his frustration over the RBI policy, Chidambaram had said that the government will walk alone if needed, thereby meaning it would take unilateral boosting measures. 

Today’s RBI policy can be analysed from two broad aspects: first, how RBI gives a little more push to growth to help government; second, how in the midst of an inflationary situation, RBI still attempts to tackle the prices. To the extent either of these aims are realised, it would be a great help to the new government. The policy statement by Raghuram Rajan as a matter of fact explicitly takes note of the robust political situation which he interpreted as a positive for a reforms backed agenda of the new government. The statement observes: ‘The decisive election result, together with improved sentiment should, however, create a conducive environment for comprehensive policy actions and a revival in aggregate demand as well as a gradual recovery of growth during the course of the year.’

As a signal of its appreciation of growth imperatives, RBI has cut the statutory liquidity ratio (SLR) by 50 bps from 23 per cent of NDTL to 22.5 per cent of NDTL. SLR is the obligation of the banks to put the stated proportion of their funds into government securities. In effect, it means banks’ funding of government’s fiscal deficit.

The SLR has been pared specifically keeping in view the need for greater credit in expectation of a recovery of the economy. RBI estimates overall GDP growth rate to pick up from the current 4.7 per cent to between five and six per cent with a bias upwards. To the extent the funds are therefore impounded in this manner, the banks’ ability to extend credit to industry and businesses are curtailed. Any relaxation in these norms will mean that the banks’ will be able to push more funds to industry and business and thus help the cause of growth. This is also a desired goal of the government which seeks to push up the sagging growth levels. 

At the same time, RBI has stated that a deeper reduction of the SLR obligation could not be undertaken because in fixing this the RBI had to keep in mind the additional funds requirements of the government as well. A steep cut in SLR might have meant that the government would have faced difficulty in mobilising funds for its future borrowing programmes. Such a development would have jacked up the borrowing costs for government as well. So this is in fact a delicate balancing act which RBI had just now initiated. Any further cuts in SLR will critically depend on the fiscal trends

The second instrument at the hand of the RBI to encourage growth would have been to cut its basic policy interest rates. But RBI has chosen to keep all other rates like the repo rate unchanged. 

RBI stated its inability to adopt a more expansionary credit policy by reducing policy rates in the light of the inflation trends. The bank noted the rise in CPI inflation in April mainly on the back of rising prices of food articles like fruits and vegetables, sugar, pulses and milk. The Bank expects some of these price pressures to continue in may. Additionally, the El Nino factor, if that happens, could further queer the pitch. 

But it has refrained from raising the policy rates either even though it noted sufficient provocation for that. The reason being what it stated: ‘at this juncture, it is appropriate to leave the policy rate unchanged, and to allow the disinflationary effects of rate increases undertaken during 

September 2013-January 2014 to mitigate inflationary pressures in the economy’. There are some interesting sidelights in the RBI policy as well which are mainly technical in nature. RBI has allowed the foreign portfolio investors to participate in the domestic exchange trade currency derivatives market. Presumably this has been done to undercut the non-deliverable forward contracts in rupees which were flourishing in some overseas centres. These forward deals in rupee against the dollar were influencing the exchange rate in Indian markets. At time these developments played havoc. 

A deep foreign exchange market which also provides products for hedging the exchange rate exposure of investors could altogether take the basis for the overseas markets. The overseas markets were beyond the control or influence of the RBI. A domestic market could be properly supervised and regulated. This would be a far better bargain for stabilising Indian foreign exchange market and the exchange rate. IPA