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Monetary and Credit Policy for 2001-02 -- Positive, pragmatic and proactive

S. Venkitaramanan

THE RBI Governor, Dr Bimal Jalan's Monetary and Credit Policy for the Slack Season 2001 has been on expected lines. It is worth noting that Dr Jalan had announced ahead of his Credit Policy statement that there would be no change in such critical variabl es as CRR and bank rate. This is in pursuance of Dr Jalan's emphasis on demystifying the announcement related to the Credit Policy.

Overall, the latest edition of the Credit Policy is pragmatic and reform-oriented. Dr Jalan has rightly decided that this is not the right time to reduce the bank rate further. In so deciding, he has obviously kept in mind two important aspects -- the operational costs of intermediation by the banks and the heavy load of Government borrowing, which could definitely lead to an upward pressure on interest rates.

It is not as if a reduction in interest rate per se will lead to a spurt in corporate investments. Corporate investments depend on many factors, most important being the demands for the output of industry. In the current climate of `low' public investmen ts and intensified competition from abroad, corporate expectations of demand have inevitably declined.

While corporates have been arguing in favour of a reduction in interest rate, such a reduction by itself is not enough to encourage further investment activity. Further, a reduction in interest rate can have an impact on forex inflows. Though the inflati on rate in India is low, it has not declined that much to encourage the Governor to attempt a further reduction in interest rate at this stage.

While Dr Jalan has orchestrated his interest rate policy in conjunction with that of Government, he has kept further options open. He has reserved his right to change the interest rates as well as CRR, obviously in the direction of tightening, if circums tances so warrant. At the same time, the Governor has suggested that he is generally in favour of a softer monetary stance. This may well mean that he will nudge the interest rates to a lower level if macroeconomic circumstances permit.

The Credit Policy has made a number of significant departures, especially in relation to export financing. Keeping in view the importance of export earnings, the Governor has relaxed procedural and other constraints in the disbursal of export credit. He has also reduced the rate of interest to exporters. He has further promised that the RBI will continue to interact with the Export Advisory Committees to sort out any procedural bottlenecks that might remain. A very positive and proactive policy, which d oes not `dismiss' exporters' practical concerns as irrelevant or unjustified!

It is important to note that the unfortunate events in the Madhavapura and other cooperative banks and their overflow into larger banks have not distracted the attention of the Governor to much-needed reform in the banking sector.

Turning to cooperative banks in particular, the Governor has rightly focussed attention on intensifying supervision, given the duality of control. His suggestion to set up an apex supervisory body for cooperative banks merits attention, though questions of staffing, experience and control of the new entity will have to be solved.

Although the stock market irregularities have naturally drawn the Governor's attention, he is not unduly perturbed, considering that the total investments by banks in the capital market have been in the range of 1-2 per cent. He has promised promulgation of new guidelines to govern commercial banks' exposure to the capital market. Promulgation of guidelines per se is not enough. It is ultimately a question of the ability and training of the bank staff to handle the problems posed by valuation of equity in a volatile market.

The fact that banks are now permitted to go up to a

specified percentage of their advances in investments or lending to capital market should not turn out to be an invitation to disaster. This, in turn, requires special attention by the RBI to the training and placement of appropriate staff in banks deali ng with lending to the capital market. The Governor has, however, rightly decided not to go back on his earlier relaxations allowing banks to lend against equity. The RBI will do well, however, to sharpen his instructions to banks regarding training and placement of appropriate staff to deal with this admittedly `hazardous' venture.

Dr Jalan has spent a considerable part of his policy statement on the external environment. He has noted, with satisfaction, the emergence of robust forex reserves and a comfortable current deficit situation. His measures to increase exports are timely a nd well-tuned to encourage a further growth of export earnings.

The Governor concedes that there is a strong case for continuing the current regime of exchange rate policy of focussing and managing volatility with no fixed rate target, while allowing the underlying demand and supply conditions to determine the exchan ge rate movements over a period in an orderly way. The Governor's formula to follow the same approach of watchfulness, caution and flexibility will be welcomed.

There is no indication, however, of the Governor's preference for either further depreciation or appreciation of the rupee. He has, however, cautioned that, given the absence of a lender of last resort in international finance, emerging countries have in creasingly to rely largely on their own resources during external exigencies. Hence his emphasis on keeping adequate reserves -- presumably at its current high level.

This should not, however, preclude continuance of the policy announced by the Governor of meeting the needs of oil exporters and debt service payments from the forex reserves. Continuance of this policy will help reduce volatility, which is endemic to in ter-bank forex trading, to which the Governor has drawn particular attention and which distorts exchange rate movements without reference to economic fundamentals.

Dr Jalan has availed of the Credit Policy announcement to push through further reforms in respect of prudential norms. The introduction of the 90-day limit, instead of 180 days for overdues is on expected lines, and is also in consonance with the interna tional practice. Bankers will, however, find it difficult to unwind their positions and make arrangements regarding disposal of assets within the time limit allowed them. The Governor may need to consider a longer transition period, particularly in respe ct of financial institutions. The same argument holds good for exposure norms regarding individual banks and institutions to single borrowers.

While the Governor has done well to bring the banking system in line with international practice, the legal system still leaves a great deal to be decided. Indian banks and institutions are not in a position to effect as quick a recovery of their dues as their peers abroad. The Governor will need to continue his emphasis on action by the Government in pushing through the necessary legislation to enable speedy recovery.

In regard to the RBI itself, the Governor has been consciously undertaking steps to distance the RBI from the ownership of the institutions it supervises, such as SBI, the National Housing Bank, and so on. The Governor has already declared his intention of divesting the RBI's investments in these institutions in favour of the Government. This is not, however, as simple a task as he makes it out to be.

The Government will have to find large sums of money to take over the shares held by the RBI. Questions of valuation and payment will also arise. The RBI may well find itself financing such transactions by lending the requisite amount to the Government. In the current state of fiscal distress, the Government may not be able to buy out the RBI's holdings of shares in these institutions, however desirable the suggestion may be.

Regarding the government security market, the RBI deserves credit for the substantial degree of sophistication it has introduced over the last few years. The central bank now proposes that it should be delinked from the management of government debt. Whi le in theory the proposal looks attractive, in practice it is bound to create problems, especially in the period of transition. The Government will have to set up a new agency to handle this task.

The RBI may find itself nurturing and housing the new entity. What is more important in the matter of popularisation of Government scrip holding is the much-needed amendment of the related Public Debt Act, which the RBI has recommended. The Government is , however, still dithering on the legal amendments.

All in all, Dr Jalan's latest Credit Policy is in line with its predecessors, in that it combines practicality with reformist zeal. He has devoted considerable attention to the nuts and bolts of reforms. One hopes the Governor's well-intentioned projecti ons and policy will work out successfully and not be impeded by unforeseen developments, as happened with Mr Sinha's Budget.

Picture: A leaner, meaner RBI? In the Credit Policy, the Governor has declared his intention of divesting the RBI's investments in such institutions as SBI, the National Housing Bank, and so on, in favour of the Government. This is not, however, as simpl e a task as he makes it out to be.

Picture by Paul Noronha