The Hindu : Monetary Policy — In the horns of a dilemma

Online edition of India's National Newspaper
Saturday, May 10, 2003

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Monetary Policy — In the horns of a dilemma

By C. R. L. Narasimhan

The latest monetary measures — the lowering of the CRR and the Bank Rate — might have been anticipated. Their justification in the current context can be questioned both from a theoretical and practical standpoint.

The two visible aspects of the Monetary and Credit Policy (2003-04) have been the reduction in the Bank Rate and in the cash reserve ratio (CRR) by an identical 0.25 per cent.

The Bank Rate has now come down to 6 per cent. The CRR has been reduced from 4.75 per cent to 4.50 per cent with the change however coming into force only from mid-June. The bank rate is the traditional signalling device available to any central bank in its pursuit of monetary management. It is supposed to set the level of all other market determined interest rates.

In recent times however the efficacy of the bank rate in monetary management is not very pronounced. In India the monetary policy had ignored this tool altogether for a while. After it was resurrected after a fairly long period of hibernation it has been brought down steeply, as it turned out, with mixed results. As the latest monetary policy records the reduction has been by as much as five percentage points in five years making it the steepest fall in the bank rate since Independence. Yet it is by no means clear whether the fall in the bank rate led or followed the general decline in the interest rates. The point is other monetary weapons, especially the open market operations (OMOs) have been used with more potent effect to realise specific goals. Another pointer to the relative insignificance of the bank rate is seen in the current Indian context where the repo rate (at 5 per cent) rather than the Bank Rate determines the level of short-term interest rates.

The CRR reduction will have the intended effect of pumping in liquidity by as much as Rs. 2,500 crores. Here again its relevance in the current context has been questioned. As a monetary tool it no doubt makes a greater impact than the Bank Rate but given that there is already a surfeit of liquidity there is very little monetary justification for a CRR cut at this juncture. It is certain that the Reserve Bank of India has intended it to be a reform measure, committed as it is to the medium term goal of bringing down statutory preemptions. The CRR itself will have to come down to 3 per cent over the term. It has already come down a long way, from 11 per cent in August 1998 to 4.75 per cent in November 2002. Over the last three years, the CRR has been brought down by four percentage points.

The central banks have been welcomed on the ground that they aid recovery by promising abundant and (even more) affordable credit. Besides, the RBI has had the difficult role of guiding sentiment, in the gilts market especially. A change in the interest rate stance cannot be abrupt despite its candid admission that "there may not be significant potential for further downward movement in interest rates.'' The present nominal and real interest rates are relatively low.

The monetary policy's key dilemma is this: it cannot waver from its well-established stance, which is "provision for adequate liquidity to meet the needs of the industrial sector.'' It might be sooner than is realised but the RBI may have to resolve the inherent contradiction in its interest rate policy.

The key topical issue is the impact of an apparently unidirectional interest rate movements on the savings class especially when inflation is on the resurgence. By the end of March 31, 2003 the Wholesale Price Index (WPI), the most widely used measure for inflation, had gone up to 6.2 per cent on a point-to-point basis. It had remained low at around 4 per cent until January this year. Although the RBI expects the inflation rate to come down, it is evident that a significant harm has already been caused to the savers. Much before the credit policy it has been pointed out that the low rates of deposit rates when viewed in conjunction with the price situation were already yielding a negative real rate of return. Evidently the hasty moves of some big banks to push down the deposit rates will cause further harm.

That brings us to the larger question. How come that the genuine concerns of the depositors are so frequently ignored? Evidently there is no body to represent the interests of the savings class. For them it is not the periodic lowering of interest rates alone that is a matter of concern.

Having to earn a negative return is one troublesome aspect but when viewed as part of the mess into which many of them have landed through some traditional investment avenues, the plight of depositors becomes pitiable.

For many investors who have lost in the stock markets, mutual funds and NBFCs and even in co-operative banks there is apparently no hope, no light at the end of the dark tunnel.

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