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RBI annual report 1999-00 prefers status quo

T.B. Kapali

THE diagnosis is comprehensive and goes to the root of the many maladies afflicting the Indian financial system. But the cure offered would appear to fall far short of actual requirements.

Indeed, considering the magnitude of the problems on hand, one would have hoped for far more drastic remedies.

A stoic acceptance of the status quo though the imbalances in the present scheme of things are quite clear. That could well sum up the Reserve Bank of India's annual report for 1999-00.

In the sphere of monetary management, for instance, the report does recognise the immense difficulties which the central bank's concomitant responsibilities with respect to public debt management creates. But the central bank shies away from suggesting d rastic solutions to clear the mess.

The farthest the RBI is prepared to go is suggest a Fiscal Responsibility Law (FRL) which will work towards fiscal sustainability in the medium term. While the RBI does say that such a law, to be credible, should include stringent requirements for transp arency, strong enforcement mechanisms, place statutory limits on borrowings and stabilisation of the debt/GDP ratio and so on, one would think that is still not going far enough. From a larger perspective, there could even be philosophical objections to placing limits on the Government's ability to spend in a developing country.

As of now, the fiscal deficit and the means of financing it (mainly market borrowings) are just a balancing figure in the Government's budget. The Government well knows that the RBI could be banked upon to finance the deficit - somehow. Inherent in this arrangement is the potential for the Government to circumvent or totally violate whatever limits a FRL may impose.

The impunity with which Governments have got around the bar on the creation of fresh ad hoc treasury bills (low coupon government paper with no date of redemption which the RBI bought by printing fresh currency) after the agreement to phase them out is e nough evidence to showcase the mischief-potential of mutual agreements and laws which do not go far enough. (Instead of buying low coupon and irredeemable Govt paper with fresh currency, the RBI now buys redeemable Govt paper carrying market-related coup on).

A more radical step would be to totally delink the RBI from public debt management, especially at the primary issue stage.

Let the Government decide the size of its deficit -- taking into account its spending preferences and more importantly, the marketability of its debt. The RBI would then be left free to focus solely on monetary management (pursuing price stability and en suring adequate availability of credit for productive activity) -- through interest rate targeting and other such instruments which can enable a focussed approach to the conduct of monetary policy.

Such a focussed approach could also largely contribute towards attaining financial system stability -- a dominant objective of macro-economic management. It will avoid conflicts of interest of the kind the RBI is facing now -- where it deliberately build s asset/liability mismatches in the financial system in the process of executing its public debt management responsibilities.