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Whose policy is it anyway?

BS City Editor

CREDIT POLICY

When Finance Minister Yashwant Sinha speaks about interest rates, and he does so more often than Reserve Bank of India governor Bimal Jalan, he is only trying to be helpful!

Or so he would like to believe.

To be sure, Sinha always qualifies his statements saying RBI is the best judge about the timing of how and when interest rates should be cut. But only the naive can deny the pressure this puts on the central bank.

Jalan, on his part, has perfected the art of hearing but not listening.

Though there are times when it gets messy like it did in 1998. The sustained battle of wits between former finance secretary Vijay Kelkar and him on which way interest rates should move -- south or north -- is still fresh in public memory.

Even though both sides wanted to downplay the "differences" of perception, nobody could miss the tension between the ministry and the central bank. The tussle between the RBI and former commerce minister Ramakrishna Hegde on the export credit front is also well known.

There have also been times like last year when Jalan succumbed to the pressure and cut rates only to rollback after three months causing the RBI considerable embarrassment.

Does this mean that the monetary and credit policy is dictated by the North Block and drafted at the Mint Street in Bombay? No. Not quite so literally, even though it may seem so at times.

It is not so much what Sinha says but what he does that is the source of problems. It is because of his actions, not speeches, that the Credit Policy gets driven by the compulsions and cares of the finance ministry.

How ?

The fact is that the overall macroeconomic policy continues to be dominated by the fisc both in terms of the numbers as well as the decision-making process. The way the fisc is managed -- the quality of fiscal adjustment not just the level of the deficit, the quality of revenues, the quality of expenditures, and the nature of adjustment both at the Centre and the states -- have a significant bearing on growth.

The result is that the monetary policy is operating on a given fiscal determinant. Given the fact that the fiscal determinant is Sinha's beat, it axiomatically follows that monetary policy gets determined by fiscal consideration of the government and not the economy.

It is Sinha who pulls the strings, Jalan merely tries to push it. It should be clear that within that framework, the monetary policy cannot deliver much.

It might be argued that under C Rangarajan, the central bank gained substantial freedom to conduct monetary policy primarily by getting the government to agree to pay market rates of interest for its borrowings and also by reducing its right to monetise deficits at will.

The discontinuation of the automatic monetisation of central government deficits was a giant step towards fiscal correction as well as giving the RBI functional autonomy in the conduct of monetary policy.

But following the liberalisation of the external sector, capital inflows are increasing which has meant that in the balance sheet of the RBI, the foreign currency assets have been playing a larger role than the domestic borrowings.

Now, if a central bank has to maintain macroeconomic stability, in particular stability with regard to the external sector, there has to be some freedom available to the RBI with regard to the creation of reserve money. There is none available.

Even though the entire economic regime has changed, RBI has got just one degree of freedom or manoeuvrability through the ways and means agreement.

Because of this, RBI has absolutely the bare minimum manoeuvrability in regard to monetisation. Jalan has made the finance ministry see the lack of alignment in the overall interest rate matrix and cut the administered interest rates on politically sensitive areas like small savings and public provident funds.

But the stumbling block is the high government borrowing programme. The RBI thus doesn't have the operational freedom for monetary policy management and the lack of it is getting in the way of efficiency in monetary management.

If this wasn't enough, the central bank also has another strategy to control the mind of the bank. This is the Trojan horse strategy. It is no coincidence that a majority of the RBI governors have been ex-finance secretaries.

Be it Manmohan Singh, S Venkitaraman, R N Malhotra or I G Patel. Bimal Jalan also has had his mandatory training at the North Block. He was finance secretary under V P Singh.

All these gentlemen are coached, "educated" and trained -- domesticated as they call it -- in the finance ministry. And even when they sit at the Mint Street, they can help think in North Block terms. Is it then surprising that it is under Rangarajan (who was not never in the ministry) that the RBI made the biggest headway on the autonomy issue so far?

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