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The Rediff Business Special: Raghbendra Jha

'The credit policy can have impact if it allows the banks freedom to shape their own lending operations'

The Reserve Bank of India's credit and monetary policy has traditionally looked at two aspects: one, the interest rate policy; two, the monetary growth target.

Ideally, the interest rate should be lowered because the economy is in a bit of recession. However, the interest rate cannot be lowered at this point in time because it will put a lot of pressure on the rupee. The RBI is very interested in keeping the rupee firm.

So, I don't really expect any serious cut in the interest rate in the short-term or long-term. The money supply growth rate is in excess by three to four per cent than what was targeted in the last credit policy.

I think the RBI is not inclined to control that or reduce the rate of monetary growth because with the interest at this level, it will have too little to fight the recessionary tendencies.

The money supply growth is hard to control because the RBI controls only the monetary growth. The rest of M3 or even M1, called the inside money, is controlled by the banking system. (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.)

Ideally, the monetary policy should give an indication to how the RBI plans to tackle the money supply. So, even if the money supply growth rate cannot be controlled by the monetary policy, it should at least act as an important guide post.

In India, the credit policy has been a biannual affair not by design but due to tradition. The interest rate in India has been under the control of the central bank for the longest period. In Western countries like the US, Canada or England, the interest rate targets and reserves are being reviewed on a weekly basis because of the open market operations. However, in India, the open market operation is still in the state of infancy.

As the open market operations become more and more important in the Indian context, one would expect the short-term interest rates to gain in significance. If that does not happen on a weekly basis, it should happen at least on a monthly basis. And if that happens, then some of the pressure on interest rate at the credit policy time can be taken care of.

So, the credit policy as a biannual exercise will become less important. Dr Bimal Jalan is moving in that direction. But I don't know whether the open market and repo trading are becoming much more important in India. I guess he feels that in a couple of months or a few years, that will happen.

There is one fear that the investment in the fixed capital is almost at a standstill. What is happening is, the working capital investment has dipped. It has been very little because of the recessionary tendencies. The statutory liquidity ratio is still quite high and lending to the industries is putting pressure on the banks which feel that there are risks in getting back returns.

(Statutory liquidity ratio: Banks in India are required (by the RBI) to maintain 31.5 per cent of their demand and time liabilities in government securities and certain approved securities. These are collectively known as SLR securities. The buying and selling of these securities was the seed of the 1992 scam. The RBI has promised to bring down the SLR ratio to 25 per cent in three years time.)

So, I think the credit policy can have impact if it allows the banks freedom to shape their own lending operations. It is not that the banks do not want to lend but the returns on primary lending are very low. So one major improvement that can be made is reduction of the SLR while allowing banks to operate freely.

Our interest rates are very high. Even real interest rates are very high compared to our trading partners in other countries.

Why? One important point is that the government wants to prop up the rupee. And if the rupee depreciates, the foreign investors will pull out. India cannot afford that. So as a consequence the interest rate has to be high.

The only way to bring down the interest rate is to reduce government borrowing. And there is simply no escape from this fact. The government is borrowing heavily to repay the loans and it is not earning much through taxes. And it is a non-sustainable situation.

So the government must improve the fiscal side of the monetary policy. The growth can only come from the fiscal side and not from the monetary side at the moment. And therefore the government must expand the infrastructure sector and reduce subsidies. It takes a lot of political will to do that.

If I had a chance to present the credit policy, then I would not have been very keen to peg the rupee value to the dollar. I would have taken a broader view.

If you look at the southeast Asian countries, their currencies were pegged to the US dollar and they were appreciating and dominating the regional currency leader, the Japanese yen. So, we have to target the exchange rate to what is called as the real exchange rate.

Now, we have a situation where the vegetables are very expensive. And the government is scared of losing money, to buy the foreign reserves for vegetables, because it feels that it won't be able to defend the rupee against the dollar tomorrow.

So the rupee is being propped up by whatever $20 billion we have in the forex reserves. If you have to prop up your currency, you must have more dollars. For example, a country like Singapore has $ 68 billion in its reserves, so it can defend its currency. So we should take holistic view of it and enlarge the panorama. So we must not look at the US dollar alone. We have to keep parity with other currencies too.

(Raghbendra Jha is a professor with the Indira Gandhi Institute of Development Research, Bombay)

India's credit policy in 1998