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April 17, 1999


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Business Commentary/ R C Murthy

Rate cuts can wait; Jalan must recast banking

The ongoing debate between the finance ministry and the Reserve Bank of India on interest rates has added a new dimension to the general discussion on Credit Policy. (The policy for the first half of 1999-2000 will be announced on April 20 by the RBI governor Bimal Jalan.)

In fact, it would have snowballed into a major controversy but for the political crisis. Till recently, such differences were not taken note of since the RBI's independence was considered dead as a dodo.

With financial liberalisation underway, the old lady on the Mint Road, now called the Bhagat Singh Road, is trying regain its autonomy.

Pointing an accusing finger at each other will only allow the issue to degenerate into a slanging match. And those in glass houses can't afford to throw stones. If lower interest rates affect the stability of commercial banks, one has to find other ways to protect them.

What has the RBI been doing all along? While southeast Asia tightened norms for non-performing assets of banks following the currency crisis a year ago, the RBI is trying to get a grip over the problem now.

Three major points emerge from the discussion: one, the fiscal deficit this year is too large, and consequently liquidity in the economy is too high as to make it difficult for the RBI's interest rate cuts to be effective; two, the government must pay for its fiscal profligacy; and three, lower interest rates should not result in real interest rates turning negative because of possible resurgence of inflation.

Granted the country's central bank should regain its independence, which its governor should defend. But comparison with its counterparts, the Federal Reserve of the US and Bundesbank of Germany is out of place at this stage of India's development.

While safeguarding the value of the rupee and keeping inflation under control, the RBI has to be proactive, if necessary, to further economic development.

The fiscal deficit this year is projected high precisely because of the need to revive the economy. The RBI has an obligation to enter into a dialogue with the government on how the fiscal policy can be finetuned in order that the monetary policy can be effective.

To say that the fiscal deficit is large is not enough. Also, the argument is not correct that the government must pay the price for the large fiscal deficit and the consequent huge market borrowings. The RBI is obliged to say under what conditions it can put its monetary measures in place to complement the fiscal policy.

Obviously, the finance ministry wanted a second round of cuts in interest rates. The first, a one percentage point cut in bank rate, followed the Union Budget on February 27.

But Bimal Jalan will be right if he steers clear of further cuts at this juncture. April is not an opportune time for any major short-term initiative on that front. Especially this year when the political situation is in a state of flux. The best scenario one can visualise is Parliament approving this year's Finance Bill and some sort of continuity in governance, if there is a change of government.

Jalan has responded to fiscal initiatives by a one percentage point cut. He must make the next move on interest rates only 3-4 months later when monsoon trends are clear.

A good monsoon is conducive for taking calculated risks. And, one should play safe if it is a not-so-good one. Because reining in price expectations would be the major task of the monetary authorities then.

One need not counsel Jalan to be cautious. His reflexes work that way. On April 20, he is expected to focus on structural issues affecting the banking system. Like the induction of universal banking concept now or later; tackling the NPA problem, creating the right climate and motivation for bank staff to lend, and improving the credit delivery mechansim, that is, the efficiency in reaching the bank funds to users at the right time.

A fiscal policy, backed by appropriate monetary policy, can work wonders. But a stand-alone monetary policy will play havoc. By being proactive and by effecting interest rate cuts at an appropriate time, say three months hence, Jalan would contribute to economic recovery.

Meanwhile, the Union government should try to tighten the fiscal policy. That lends credibility and the market will welcome it. All this of course after the ongoing political storm subsides to give way to calm.

R C Murthy

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