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Business Commentary/ R C Murthy

Bimal Jalan missed the opportunity to stimulate business sentiment

Reserve Bank Governor Bimal Jalan is not convinced the timing is right for a bank rate cut. Instead, he has opted for a very liberal liquidity creation by cutting the cash reserve ratio of banks to 9 per cent.

He bent backwards to explain how disoriented the domestic savings interest rate structure is and what corrections are required.

If the bank rate were to be cut, the entire interest rate structure will have to come down. Any further fall in deposit interest rates, in RBI's view, is not considered conducive to growth in domestic savings. And, it's contrary to the larger objective of lifting domestic savings to 30 per cent of gross domestic product, as promised in the National Democratic Alliance manifesto.

Jalan has listed out the terms on which he can go along. For him deeds count, not words. He wants action on the fiscal front.

First, increase in revenues. Like a hike in income-tax surcharge and public sector unit divestment. Second, a cut in public expenditure and PSU deficits.

The experience is mixed. The government's earnestness is seen in the recent 40 per cent diesel price hike. There was no roll-back despite pressure from transporters. Full marks to Vajpayee.

On the other hand, constitution of a jumbo Cabinet at the Centre and the concomitant increase in the ministries are not a happy beginning for expenditure cuts.

It appears Jalan is also haunted by fears of inflation resurgence. Rising oil prices are posing a problem. A hike in transport costs will have a cascading effect on the entire economy.

The element of subsidy in LPG, kerosene and petroleum feedstocks used in fertiliser manufacture will go up.

The Reserve Bank talks of "less than 4.8 per cent price inflation" this year. This amounts to doubling from the present level of two per cent, though lower than the level last year.

Normally, price expectations at this time of the year are bearish. Crops start moving to markets and the supply situation is better than the slack season.

There is some uncertainty this year. The monsoon rains were uneven -- floods in some states and scanty rainfall in many others. Shortages, if any, will have to be met by imports. Taking care of weaker sections is important.

Jalan thinks the flood of liquidity would do the trick. He is trying to achieve the effect of a bank rate cut by the excess liquidity weapon.

If he succeeds, he will also have squeezed the spread between the average lending rate and average deposit interest rate. That is a step towards making banks efficient and global integration.

Yes, the liquidity in the economy by November-end will be such that banks will be searching for good customers. But will they pick up his signal and drop their lending rates below their prime lending rates? Most of the bankers have indicated otherwise.

Experience shows that fear of a rise in non-performing assets can keep branch managers away from lending unless they are top class customers.

Even here there is a problem. Who dreamt that the Essar group, categorised A1 till a year ago, could become a financial untouchable that it is today, following the floating rate note repayment default?

This raises the basic question: Should the Reserve Bank be proactive or should it just keep the devil away?

The core sectors of steel and cement are turning round and it is important at this stage to give a boost to investment, which is driven by business sentiment.

Bank rate change was a weapon to stimulate that sentiment. Jalan missed the opportunity.

ALSO SEE

RBI Governor Bimal Jalan's policy statement

RBI's Monetary and Credit Policy 1999-2000

RBI's Monetary and Credit Policy 1998-1999

R C Murthy

Business