The trends in non-food credit, money supply and reserve money, which are among the major variables to be reckoned with in policy formulation, are somewhat mixed.
The one concern that may be expected to be at the centre of the forthcoming Annual Policy Statement of the Reserve Bank of India (RBI) will be the inflation — raging currently at more than 7 per cent.
The second point would be the slow-down in the growth of the economy — from the heady heights it has seen in recent years. However, to the RBI’s comfort, the controversy on the choice between price stability and growth has been settled by the Finance Minister emphatically declaring that he would prefer the former to the latter — given the impact of inflation on a large section of the population. Although the central bank can concentrate on fire-fighting measures to preserve the purchasing power of the rupee, it still has to ensure that there is soft landing for the economy.
The trends in non-food credit (NFC), money supply (MS) and reserve money (RM), which are among the major variables to be reckoned with in policy formulation, are somewhat mixed. Thus during 2007-08 the growth rate of NFC, including investments, was 21.9 per cent against 27.3 in the previous year. The percentage increases in the corresponding years in MS (M3) were 20.6 and 21.3.
Lagged Effect
As on April 11, 2008, RM grew by 26.4 per cent year-on-year in contrast to 22.6 per cent on the relative date a year back. Two points emerge from the data. In the first place, there is a deceleration in the growth of NFC and M3, although the latter is still above what the central bank desired. Secondly, RM continues to grow at an accelerated pace. The deceleration noted above is due to the lagged effect of the previous policy measures, especially in relation to the periodical hiking of Cash Reserve Ratio (CRR).
As on April 11, 2008, RM grew by 26.4 per cent year-on-year in contrast to 22.6 per cent on the relative date a year back. Two points emerge from the data. In the first place, there is a deceleration in the growth of NFC and M3, although the latter is still above what the central bank desired. Secondly, RM continues to grow at an accelerated pace. The deceleration noted above is due to the lagged effect of the previous policy measures, especially in relation to the periodical hiking of Cash Reserve Ratio (CRR).
The growth in RM has been the result of the unceasing inflow of foreign funds adding to the net foreign exchange assets of the RBI due to sterilisation. Thus, as on April 11, 2008, these assets rose by a whopping 43.7 per cent year-on-year against 23.9 per cent earlier. The recent hike in CRR may partly impound the inflows that have occurred so far. But one does not know what the future has in store. It appears that despite the stock market crash, FIIs haven’t rushed to the exit door.
According to reports, FIIs are diverting their funds from shares to treasury bills of short duration, thus keeping the rupee funds in the country, for possible redeployment in the stock market at an appropriate time.
Surplus mode
It is somewhat difficult to get a clear picture of the surplus liquidity in the economy. After suffering from a shortage of funds during March, due to tax payments of customers necessitating the injection of liquidity by the RBI, the system is back in a surplus mode. However, the amounts have fluctuated widely. Thus, on April 7 and 11, the reverse repo operations of the RBI that absorb liquidity were Rs 37,370 crore and Rs 79,005 crore, the number of banks involved being 37 and 58, respectively.
It is somewhat difficult to get a clear picture of the surplus liquidity in the economy. After suffering from a shortage of funds during March, due to tax payments of customers necessitating the injection of liquidity by the RBI, the system is back in a surplus mode. However, the amounts have fluctuated widely. Thus, on April 7 and 11, the reverse repo operations of the RBI that absorb liquidity were Rs 37,370 crore and Rs 79,005 crore, the number of banks involved being 37 and 58, respectively.
However, on April 17, the amount came down to Rs 7,045 crore from 10 banks. The figures given above will undergo changes when the RBI presents more recent data. Some of the statistics are vitiated by the year-end syndrome with competitive window dressing by banks to project good images of themselves to the Government, the RBI and the public.
The RBI needs to look into the matter, if necessary by appointing an expert group, to tackle the problem by studying the practices in other countries. The CRR actually maintained by the system was 8.61 per cent, as on March 28, 2008, against the prescribed 7.5 per cent, and 8 per cent to be enforced soon.
Hardening interest rates
The actual ratio includes transaction balances for inter-bank settlements also. Banks may meet the shortages in CRR by disinvestments in the securities prescribed under Statutory Liquidity Ratio, if necessary. They are currently around 30 per cent of deposit liabilities as against the statutory minimum of 25 per cent. It would mean a decline in security values with a consequent rise in yields.
This, coupled with the increase in CRR, will lead to some hardening of interest rates in the system. Hence, there is no need for the RBI to raise the policy rates at this time.
As long as the system is not dependent on the central bank, the repo rate, like the bank rate, may not be effective in itself to influence the system. However, as the year progresses, there may be a need to raise the CRR further for the reasons described below.
There are a number of factors that point to a spurt in NFC and MS. The loan waiver, even if limited to Rs 60,000 crore, effectively means pumping that much money into the system by making fresh loans available to defaulters. Added to this will be the pressure arising from ‘inclusive banking’, which is the new mantra of the politician. Those who enter the system through nominal deposits would naturally expect a benefit in the form of a loan. It may not be long before the authorities issue instructions to the banks to sustain the interest of the new depositors in banking through overdrafts of limited amounts to meet urgent expenditures, so that they do not have to approach moneylenders.
Extra emoluments
The substantial tax benefits for individuals embedded in the Budget will mean additional consumption expenditure. Another factor that would add to MS would be the increase in salaries of all employees of the Government and the public sector due to the recommendations of the Sixth Pay Commission.
The substantial tax benefits for individuals embedded in the Budget will mean additional consumption expenditure. Another factor that would add to MS would be the increase in salaries of all employees of the Government and the public sector due to the recommendations of the Sixth Pay Commission.
The extra emoluments would likely go into expenditure on items like consumer durables. The least that the Government could do is to credit the arrears of salaries to provident funds of the employees, instead of making cash payments, thus mitigating the impact on money supply.
One lasting contribution that Dr Reddy can make to an enduring monetary policy is to bring down the target for MS in 2008-09 to a non-inflationary level.
According to the information received by this writer from the RBI under the Right to Information Act, the methodology of estimation involves separate estimates of money demand and supply under the assumption of equilibrium in the money market, while ensuring the consistency of sources and uses of funds by the RBI, the banking sector and the Government. It uses 1.4 as the income elasticity of real demand for money.
It means that for every percentage increase in Gross Domestic Product (GDP), the real demand for money goes up by 1.4 per cent. Thus, to ensure equilibrium in the money market, it has to provide for additional money supply at 1.4 times the expected growth rate in GDP.
Withdrawal symptoms
Any extra amount like 4 or 5 per cent, provided to accommodate inflation, as has been the practice for nearly two decades, would only help to generate it. The RBI should ask itself as to what calamity would fall if this baker’s dozen of 4 or 5 per cent is not provided for. Would it be good or bad for the economy?
Any extra amount like 4 or 5 per cent, provided to accommodate inflation, as has been the practice for nearly two decades, would only help to generate it. The RBI should ask itself as to what calamity would fall if this baker’s dozen of 4 or 5 per cent is not provided for. Would it be good or bad for the economy?
The central bank can always revise its target upwards if the trends in GDP point to a higher growth than predicted. Thus, if GDP is estimated to rise by, say 8.5 per cent in 2008-09, the targeted money supply should be around 12 per cent, not 17 per cent, as it is in the current procedure.
But such a drastic cut in the growth of money supply, called ‘cold turkey’ in professional literature to refer to a disinflation measure designed to reduce inflationary expectations, may be a shock to the system as it is drunk in liquidity.
It may lead to withdrawal symptoms! So the central bank could provide for, say, a 15-per cent increase in money supply, which should get closer and closer to the real demand for money in the future.
A. Seshan
(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. The views expressed are personal.)
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