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April 22, 1999

BUDGET 1999-2000

The Rediff Business Columnist/R C Murthy

Expansionary policy from a Gov in tune with govt

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The Reserve Bank of India has opted for an expansionary credit policy over the next six months, relegating inflation control to the background, at least for the present.

There is thus a change in priorities, bringing the revival of the ailing Indian economy to the fore. Till recently, inflation control was assigned top priority.

Of course, Bimal Jalan, the RBI governor, is better placed than his predecessor Chakravarthy Rangarajan in that agricultural production has been back to normal last year. That allows room for expanding liquidity.

The 10 per cent Cash Reserve Ratio from May 8 will mean that the commercial banks will have an additional Rs 32 billion to lend. In effect, Jalan has harmonised the monetary policy with the Union Budget, which envisages sizeably enhanced market borrowings and certain steps to turn round industry. Liquidity will oil the initiatives on the industrial front.

Money supply, which includes notes in circulation, demand and time deposits with banks, is projected to grow at 15.5-16 per cent this fiscal against the annual average of 15-15.5 per cent over the past two years. The easy liquidity should lead to greater deposit mobilisation by banks.

The Reserve Bank has placed the bank deposit growth at 16.5 per cent (Rs.1.185 trillion), assuming of course inflation is under control. Whether or not these projections will be realised depends on expectations on trends in price inflation. If it is higher, the deposit growth will be lower.

Governor Jalan appears to be in tune with the government. He has clearly indicated to banks that the RBI would work for a stable interest rate regime "with policy preference for softening to the extent circumstances permit".

But Jalan denies having signaled lower interest rates. In the same breath he reiterates his preference for lower rates, thus reserving action on that front at the appropriate time.

What does this cliche mean? Jalan warns that banks should not over-extend their commitments and should match their debits and credits so that they are not caught napping when interest rates resume southward movement.

Such an exercise would not hurt profits of banks as they will not be saddled with high-cost funds. They would be able to adapt quickly to the new situation.

The difference between this and previous fiscals from the monetary policy angle is the likely demand for bank funds arising out of economic revival. In the next six months, technically known as the slack season, banks will have to reckon with the needs of public sector agencies engaged in foodgrains procurement, industry and services sectors.

Historically, demand for bank funds during the slack season is low as farmers are engaged in sowing. And in the following six months, known as busy season, demand for funds is up as farmers move crops to markets.

No longer such sharp divisions exist. Over years, the share of agriculture in gross domestic product has been declining and those of industry and services are rising. In fact, banks are busy in May- October and busier between November and the following April.

Thus, rabi crop procurement, expanding needs of industry and services would absorb some Rs 30 billion in May-October against a contraction of bank credit in these months when India was purely an agricultural economy.

There is an element of gamble in targeting for higher money supply growth. The projected growth of 15.5-16 per cent this year is rather high coming as it does over the 15-15.5 per cent annual growth over the previous years.

In 1997-98, agricultural production dipped. But it had limited impact on prices though money supply rose 15.5 per cent. That was because the Indian economy is characterised by leads and lags. The impact of any monetary measure is therefore difficult to predict.

With 16 per cent money supply growth targeted this year, there is the danger of inflation raising its ugly head. If the monsoon trends are favourable, expectations of price inflation will b nipped in the bud and the economy can easily absorb even the enhanced money supply.

Jalan has done a professional job. So far so good. He is lucky political pressures on him to cut interest rates have eased with the fall of the Vajpayee government. Of whatever hue the new government will be, it requires some time to come to grips with the economic situation. By then, the monsoon trends would be known and the time would be opportune for further action on the monetary front.

The governor used the interregnum well by concentrating on structural issues like improvements in money market such as creation of a new interim liquidity adjustment facility and refinements in the debt market operation and focusing on export credit.

R C Murthy

The RBI's Credit and Monetary Policy for 1999-2000

Budget 1999-2000

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