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Business Commentary/ R C Murthy

President's address has enough hints for Bimal Jalan

President K R Narayanan's address to Parliament on Monday has spelt out clearly the Vajpayee government's policies and plans to achieve them. That is a signal to the Reserve Bank of India of the government's intentions on the fiscal side. But action is yet to begin.

RBI Governor Bimal Jalan is obviously debating a bank rate cut this weekend. Should action on monetary policy follow or precede initiatives on the fiscal front?

Such a stance presupposes that other conditions are fulfilled and time is ripe for monetary policy changes. Captains of industry and trade are pressuring Jalan for a bank rate cut, a demand which they made unsuccessfully last April.

The governor did not oblige them and rightly so. Had he acceded to their demand, he would have probably wasted a major weapon in the RBI armoury. The Vajpayee administration was unstable then and was certaintly not in a position to take hard decisions.

The issue of interest rate cut has come to the fore now as the RBI formulates the credit policy for the next six months, technically called the busy season.

It is busy season because crops move to markets and industries that depend on raw materials seasonally available, work at peak capacity. But India has come a long way from the dual economy.

The seasonality of operations is blurred as the character of industry changed. So too demand for bank credit.

That there will be greater demand for credit in the next six months than before is crystal clear. First, there is the seasonal demand. Second, a turnround in industry is seen after a year of recession and there is an urgent need to sustain the uptrend in industrial production.

How much of the liquidity has to be enhanced? Industrial production rose by an annual 6 per cent in April-August last. The target is an annual 9 per cent over the fiscal and if possible more.

Taking the leads and lags in the transmission of monetary policy to the grassroots, the RBI should opt for a liberal estimate. The economy is in a fairly sound position and Jalan can take chances.

Money supply (M3) has grown by some 16 per cent year-on-year basis against 20 per cent last year. Inflation is at an annual 2 per cent though there are patches of dark clouds on the horizon. (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.)

The 40 per cent hike in diesel oil will push up transport costs and will have a cascading effect on the economy.

So too the liberalisation of imports of certain items under the World Trade Organisation regime. For instance, there was a sympathetic impact on prices of local fruits as high-priced stuff flooded major cities.

But these are acceptable risks that Jalan can take in the monetary policy formulation. The cash reserve ratio or CRR can be reduced by another percentage point to free some Rs 33.5 billion banks' loanable funds.

A bank rate cut in itself would neither boost demand for bank funds nor enhance their flow in the short run. But it has an immediate psychological impact and a reduction in industrial costs over a period, provided of course the rate cut is down the line.

Action on bank rate front normally follows presentation of Union budget, which outlines the action plan for the year. But it is some 17 weeks away. Industrial growth, which is just gathering momentum, needs stimulants desparately if it is to be sustained and accelerated.

The government should come out with a white paper on what it is going to do in the next 50 days in terms of economic and industrial reforms and the road blocks to be cleared in the path of infrastructure development and facilitate the private sector entry.

If the RBI Governor feels assured of action on the fiscal side, there is a clear case for a two percentage point cut in bank rate. Only a fairly large cut will have the desired psychological impact on the economy: Jalan should seek to boost the markets, enabling corporates to revive their investment plans and raise capital.

One aspect that requires careful consideration is the adverse impact of a rate cut on banks. Having burnt their fingers last year, most banks have reduced deposit interest rates in anticipation of a bank rate cut.

Moreover, the revival of industry would help reduce the non-performing assets of banks. To that extent, a rate cut will have an overall desired impact on banks if everything works well.

Will Jalan bell the cat?

R C Murthy

RBI's Credit and Monetary Policy 1999-2000

RBI's Credit and Monetary Policy 1998-1999

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