Economic Highlights

New Delhi, 30 April 2010

RBI’s Mandate

MANAGE BORROWINGS, NOT INFLATION

By Shivaji Sarkar

The Reserve Bank’s monetary policy is sectoral and too much emphasis is laid on its capability of curbing inflation. The new credit policy is like old wine in a new bottle. Each of the steps taken during the past one year has not been able to contain inflation. Additionally, there is a candid admission by the Central bank that this time too it may not succeed. Its primary concern remains managing the borrowings for the government.

Ironically, more the steps are taken to suck in liquidity more has been the inflation in recent times. In January, it took a drastic step in raising the cash reserve ratio (CRR) from 5 per cent to 5.75 and sucked in Rs 16500 crore from the scheduled commercial banks. The RBI estimated it would help limit inflation to 8.5 per cent by March end. It did not. It touched 9.9 per cent.

Would the present steps of raising the CRR by 0.25 per cent and taking Rs 12500 crore out of circulation, raising the banks’ rates parking and withdrawing money be of any help? The undertone of the Monetary Policy Statement does not suggest so. It only obliquely admits its primary responsibility of the task entrusted to it – raising funds for the government. Now it forecasts further firming up of inflationary tendencies.

The new policy is based on what RBI Governor D Subbarao states “a dilemma” – despite lower budgeted government borrowings this fiscal, fresh issuance of securities will be 36.3 per cent higher than last year’s. This means much higher borrowings in real terms and consideration of lowering liquidity. “The Reserve Bank has to do a fine balancing act and ensure that while absorbing excess liquidity, the government borrowing is not hampered”, he explains.

Fresh issuance of securities – instrument for raising government loans – in 2010-11 would be Rs 3,42,300 crore up from Rs 2,51,000 crore last year. It makes debt servicing expensive and has portent danger for managing next budget’s finances. It is also likely to make private borrowings difficult as most of the government loans are raised from open market operations. It makes private borrowing expensive and is likely to further increase commodity prices.

Inflationary trends have accentuated in the recent period and hover between 16 and 20 per cent for food items. Now the Bank says it is spreading to other areas as high prices of primary commodities result in higher expenses and these have to be recovered from the consumer. Another matter of concern is that inflation is not fueled by “supply side” factors – any shortage of supply. A major concern is the “evidence that the pricing power of corporate has returned” - a hint at cartelization.

Despite a possibility of growth many uncertainties persist. Private demand in advanced countries continues to be weak due to high unemployment rates, weak income growth and tight credit conditions. There is a risk that once the impact of the US and other government spending-stimulus wanes the recovery process would be stalled.

This apart, private consumption too has drastically come down in the country. The issue of inflation control hinges on the monsoon. Any unfavourable pattern could exacerbate food inflation, impose a fiscal burden and dampen rural consumer and investment demand, warns the RBI.  The bank’s quarterly inflation expectations survey for households indicates that household inflation expectations have remained at an elevated level.

If there is global recovery, even then it is not good news. It is likely to firm up commodity and energy prices, which even otherwise remain volatile. The recent monetary steps are likely to increase interest rates in the coming months. The scheduled commercial banks have so far not indicated this because there is yet not much of a sign of credit offtake. But it is believed that interest rates are bound to firm up as the policy would gradually raise the cost of banking operations.

Essentially this is a double-edged sword. It adds to inflation but also invites parking of money – dollars by foreign investors. The glee of the stock market is well-placed. The foreign institutional investors are likely to flock here. So would the NRIs and other investors. It raises forex reserve to $ 279 billion. This is good news as it also has a cost for managing the fund.

Evidently, it is too much to expect of the central bank to manage inflation. It is not the cause. It does not have control on all the parameters that lead to inflation, which is driven by a bad market management and the government’s unwillingness to control the elements which play truant with it. There is no shortage of most commodities and if the buffer stock is taken into account most food items are there in the stock. But the lack of an interventionist policy, tough dealing with hoarders and market manipulators, including now the corporate, are all responsible for the abnormal price situation.

The central bank can have only a limited role. Policy formulations are restricted to official money supply. There are many other sources and it is not easy to manage. This apart there is evidence of a parallel money chain. Basically, the monetary policy is restricted to transactions through the official banking system. The central bank as a regulator could in the limited sense only restrict operations. It has powers, more ethical than real and it is right to expect a miracle from it.

As a watchdog of economy, the RBI is concerned that it has to stretch itself for raising finances for the government. It affects its role as a regulator as it forces banks to put money with it, which should normally be available to the industrial and private lenders. Presently, it is concerned that government measures have not been able to create the requisite conducive atmosphere for the market to raise funds.

This has made its task of raising government borrowings easier though the chairman of State Bank of India, OP Bhat, says it has made the commercial banks’ job difficult. If the lending rates are changed “we may ourselves be out of market,” he asserts. Indeed, the country needs a proper lending policy. The lack of it can lead to a crisis for the entire banking sector.—INFA

(Copyright, India News and Feature Alliance)