The RBI’s utmost concern has been to deal with the problem of surplus liquidity, which can further push up the inflation rate. It is in this connection that the central bank has chosen to raise the Cash Reserve Ratio by an additional 25 basis points from May 24.
The Annual Policy Statement of the Reserve Bank of India (RBI) is a laudable attempt to achieve the objective of growth with stability. The underpinnings of the proposals are designed to ensure that while they tackle the current problem of inflation, they do not, at the same time, derail the economy from the path of growth experienced in the recent period.
The objectives are clearly stated in terms of priorities which are price stability, well-anchored price expectations, orderly conditions in financial markets and the sustenance of the growth momentum.
The policy has been formulated in the background of certain important developments in the economy. Thus, the annual inflation rate, which was subdued for the best part of last year, has flared up recently above 7 per cent. This is primarily the result of a general shortage of basic necessities of life such as foodgrains and edible oils.
The cost-push to prices of industrial products flows from the increase in input prices due partly to imported inflation. As a result of the pre-emptive measures taken by the RBI in the earlier quarters, the expansion in non-food credit has come down to a manageable growth rate of 22.3 per cent in 2007-08 from 28.5 per cent in the previous year.
Money supply, as measured by M3, rose by 20.7 per cent. Although it was lower than the 21.5 per cent recorded earlier, it was still above the targeted 17.5 per cent.
However, Reserve Money increased by 30.9 per cent from 23.7 per cent in 2006-07. It was primarily attributable to the inflow of foreign funds, the bulk of which was sterilised by the central bank.
Thus, during April-December 2007, the net capital inflows amounted to $81.9 billion from $30.1 billion in the corresponding period of the previous year. It amounted to a growth of 172 per cent. The accretion to forex reserves, excluding valuation changes, amounted to $67.2 billion during April-December 2007 ($16.2 billion).
The overhang of liquidity of balances under the Liquidity Adjustment Facility, Market Stabilisation Scheme and government added up to a record of Rs 2,73,694 on March 27, 2008. It came down subsequently to Rs 2,43,879 crore on April 25, 2008.
Policy Measures
Thus, in the light of the foregoing developments, the foremost concern of the Bank has been to deal with the surplus liquidity, which can push the inflation rate higher.
It is in this connection that the central bank has chosen to raise the Cash Reserve Ratio by an additional 25 basis points from May 24. This is in addition to the hikes announced only a few days ago.
There is a clear warning that there could be a further increase in CRR in the future in addition to other measures, if warranted. In doing so, the RBI has set a target of growth in money supply at 16.5-17.0 per cent in 2008-09 and increase in non-food credit by 20 per cent. The rate for M3 has been decided in the expectation of GDP growth rate of 8-8.5 per cent.
This writer understands that, given the income elasticity of demand for money at 1.4, a statistic obtained from the Bank under the Right to Information Act (RIA), the real demand for money is around 12 per cent (at the higher growth rate). The additional 5 per cent is intended to accommodate (generate, according to this writer) inflation of 5 per cent.
Repo and reverse repo rates have been left unchanged for tactical reasons. At first sight, it gives the impression that rates in the system will not be raised. But, depending on the relative position of banks, there could be changes in deposit and lending rates since they are no longer eligible to get interest from the RBI on the cash balances impounded.
For the first time in recent years, the RBI has sought to undertake a review of loans to the agricultural commodity sector by banks. It has said that, in view of the current public policy concern in regard to trading in food items, banks are required to review their advances to traders in agricultural commodities including rice, wheat, oilseed and pulses as also advances against warehouse receipts.
They are further advised to exercise caution while extending such advances to ensure that bank finance is not used for hoarding. The first such review should be completed May 15, 2008 and forwarded to the RBI for carrying out a further supervisory review of the banks’ exposure to the commodity sector.
Commodity Advances
This advice to banks is a belated recognition of the kind of damage that could be caused by bank advances against the security of such sensitive commodities as foodgrains. While it is welcome, a few comments could be made. In the first place, edible oils also should be added to the list of commodities under surveillance. Second, one does not know how a bank manager could ensure that the credit he extends is not used for hoarding.
This advice to banks is a belated recognition of the kind of damage that could be caused by bank advances against the security of such sensitive commodities as foodgrains. While it is welcome, a few comments could be made. In the first place, edible oils also should be added to the list of commodities under surveillance. Second, one does not know how a bank manager could ensure that the credit he extends is not used for hoarding.
Where the State government has prescribed a stock level, any quantity above that limit could be treated as tantamount to hoarding. The excess should not be financed at all as it encourages the violation of government order.
Third, hoarding can be done not only by traders but by farmers, rice mills, oil mills, etc. According to one report, a considerable part of market arrivals of wheat in the mandis of Punjab are stocks hoarded from the last year’s harvest. This is recognised by the tell-tale sign of loss of lustre.
During the time this writer was in charge of the Selective Credit Control Desk in RBI he observed that if the groundnut oil mills in Saurashtra stopped crushing oilseeds early in the season, it was an indication of the raw material being hoarded for processing at a more opportune time in the off-season, when prices would go up. However, keeping in view that the manufacturers and processors needed stocks for their activities, the control was relaxed suitably for them as well as small farmers.
The RBI also needs to prescribe a proforma for the review so that the data can be consolidated at the all-India level. Otherwise, each manager will submit a report in the way he thinks fit, often in a narrative form and, quite likely, in the interests of customer relation, he will certify that there is no hoarding.
Basic Statistical Return 3 was prescribed in the past to collect monthly data on selected commodity advances.
The statistics were processed and reviews undertaken by the then Banking Division in the 1970s and 1980s, at the time of the formulation of the Busy and Slack Season credit policies. The data were available within a period of six weeks.
Recently, this writer requested the Bank under the RIA to provide him with data on commodity advances. He was particularly interested in wheat advances. The RBI was good enough to oblige him. But the time-series stopped at August 2007. What is the use of such data if available only with such a time-lag?
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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