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|April 20, 1999||
The Rediff Business Special/Raghbendra Jha
Precautionary policy, no hope of an early end to recession
The Monetary and Credit Policy for 1999-2000 was announced today by the RBI Governor Bimal Jalan. Perhaps, more than at other times in the recent past, the credit policy comes against a pessimistic background.
Consider, for example, the following:
It is against this background that the Credit Policy announced today has to be evaluated. Typically, a credit policy should consider at least three different aspects.
How does the Credit Policy measure against these criteria? It has set a monetary growth (M3) target. (M1: A measure of money supply which includes all coins and notes in circulation, and personal current accounts. M3: A measure of money supply, including those covered by M2 -- a measure of money, supply, including M1, plus personal deposit accounts -- plus government deposits and deposits in currencies other than rupee.) However, in the recent past, the RBI has not been able to target M3 well -- partly because this aggregate is at least partly determined from within the system and is not amenable to exogenous targeting.
The RBI has not changed interest rates but CRR has been reduced by half a percentage (50 basis points) to 10 per cent effective May 8, 1999. This step was taken to forestall the effects of an anticipated increase in government borrowing. With higher borrowing there might be a strain on the liquidity in the system. This strain would be higher if interest rates were lowered. Hence interest rates have been kept fixed. The RBI does not expect a large increase in corporate demand for liquid funds.
The RBI has not made any effort to affect the SLR. Hence the same extent of direction of credit as of now will prevail. This is not a pleasant development. Although banks have been given more liquidity and greater flexibility of instruments, their choice of loan portfolios is still very much circumscribed.
The RBI has announced some measures to facilitate financial transactions. These include:
In addition, banks have been given more freedom in their interest policies. Proposed changes include:
Typically, fiscal policy has a longer-term perspective than monetary policy. In the presence of political uncertainty, fiscal policy has had to take on a short-term focus and monetary policy will have to provide, to some degree, a longer-term perspective.
The RBI has analysed this as implying the following: the government will borrow more than anticipated (hence the cut in CRR), and there will be need to attract foreign funds to improve the Balance of Payments situation. It has chosen measures to stabilise the rupee for which it needs to keep interest rates high. But these policies have a cost.
In the best case scenario the political uncertainty will lift soon and government borrowings will stabilise near predicted levels. In this case, the CRR cut can be translated into a cut in interest rates which would make investment more profitable and help strengthen the rupee. In the worst case scenario, political uncertainty will prevail for considerable time, an election will follow and government borrowings will rise.
In this case, the levels of interest rates required to stabilise the rupee will be much too high especially in view of continuing export sluggishness. How badly the economy would be in the second case also depends on what the RBI does now. It has chosen to be precautionary at this stage. This means that the credit policy does not give much hope for an early end to the recession.
Perhaps a small cut in interest rates could have been contemplated. The rupee is under pressure, no doubt, but that is because of political uncertainty. A lower interest rate could have improved investor sentiment and this could have helped strengthen the rupee in the next few months. The lower interest rates would have helped corporate and government debt servicing positions and the lower value of the rupee could have helped exports. But this course of action was not followed.
In sum, then, this is a precautionary credit policy. The RBI is preparing itself and the economy for the outcome of political turmoil. It has also effected some improvements in the ways in which financial transactions are done. But it has not attempted to provide any stimulus to the efforts to end the ongoing recession.
Dr Raghbendra Jha is professor, the Indira Gandhi Institute for Development Research, Bombay
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