Search the Internet          Tips  Sites: Finance, Investment

Is the Monetary & Credit Policy Dead?

An imperative statement

H N Sinor
Joint managing director, ICICI Bank

From 'slack' and 'busy' season policies to a Monetary and Credit Policy for the whole year, followed by a mid-term review, the exercise has undergone a considerable transformation.

In the 1970s, credit policy announcements were called credit policy for the slack season and the busy season, emphasising mainly the dependence of the Indian economy on the seasonal performance of the agricultural sector. However, following a strong policy focus on industrialisation, the share of agriculture in GDP underwent a gradual decline, thereby weakening the seasonal influence of agricultural sector on the overall economic activity.

Consequently, the nomenclature of the policy as busy and slack somewhat lost its importance in the 1980s. The early 1990s saw wide-ranging structural reforms being undertaken, which emphasised the role of market forces in the allocation of resources in the most efficient manner.

Since the banking system plays an important role in the efficient allocation of resources, it became necessary at that juncture for the Reserve Bank of India to reorient its approach to play the critical allocational role in the financial resource requirements of growth.

In the dynamic environment that emerged in the aftermath of the reforms, it was imperative that policy measures should be in the nature of a "contextual response", that would take into account both the previous period's economic conditions and anticipated developments during the current year.

The practice of bi-annual statements was intended to serve this very objective. Since structural measures are long term in nature, it was decided in 1998 to announce the Monetary and Credit Policy for the whole year instead of "for the first half of the year", followed by a mid-term review of the policy.

While the annual policy at the beginning of financial year (April) gives greater importance to structural measures, the policy statement for the second half of year (October) is confined to a mid-year review of monetary developments, and suggesting structural changes and short-term measures if necessary.

More than a decade after the reforms, the raison d'ˆtre for the practice of bi-annual monetary policy statements continues to remain intact, and even more relevant in some ways.

As a result of the reform process, the extent of money supply and credit, and the cost and conditions at which they are available are increasingly being determined by market forces, which respond to the policies of the RBI.

The annual monetary policy statement and the mid-term review constitute an essential channel, which RBI uses to respond to market developments on an ongoing basis.

In particular, the mid-term review acts as a formal platform for RBI to take stock of the direction of the economy in the first six months of the fiscal year, and accordingly formulate policy responses for the next half.

It is also an ideal forum for RBI to formally express its views, on a more frequent basis, on factors affecting the financial sector, such as direction of the interest rates, the level and targeted growth of money supply, and the "optimal" level of inflation in the economy.

While micro-management issues can be left to the discretion of individual players in the system, an indicative signalling of the course of core macro and financial variables is critical for providing appropriate and timely direction to the financial sector in a dynamic, market-oriented economy.

The New Capital Accord of the Basel Committee on Banking Supervision that was released in January 2001 adds urgency to the process of convergence.

The new accord, when implemented, is likely to have significant implications for the banking system as a whole. Besides requiring increased capital, it attaches urgency to the development of efficient and comprehensive internal systems for assessment and management of risks, setting up and adhering to adequate internal exposure limits and improving internal control generally.

Capital allocation is also required to be more risk sensitive and, therefore, banks will have to plan in advance so that there are no disruptions in the capital structure.

Bank managements will have to develop internal capital assessment processes in accordance with their risk profile and control environment, with these internal processes then being subjected to review and supervisory intervention since credibility is attached to risk disclosures only if they are validated by supervisors.

Effectively, to meet the pillars of the new Accord - minimum capital requirements, processes of supervisory review and market discipline - appropriate and timely supervision by the RBI would be more critical than ever before.

Hence in this context, the mid-term review of monetary and credit policy can be used as an effective platform by the RBI to assess progress made by banks in meeting prudential norms, to signal caution and to provide direction on appropriate prudential response to the changing environment.

Finally, in an era of increasing globalisation, RBI must also be able to respond to international developments and take appropriate and pre-emptive regulatory action. This constitutes an additional argument for making the mid-term review an indispensable part of the monetary policy formulation exercise.

For both the regulators and the regulated, constant vigilance is the price of growth with financial stability. And the practice of bi-annual statements will not merely be beneficial, but imperative.

Time for new hopes, letdowns

K V Krishnamurthy
Chairman & MD, Bank of India

It's time for new speculations, new hopes, and, perhaps, new disappointments. Till some years ago, when the government had all the keys and the Reserve Bank of India had all the power to drive the economy, the excitement was well deserved. It was the single-largest economic event after the budget determining the monetary policy and the economic well-being of the country.

There were many things to decide on: money supply, interest rates, banking regulations, liquidity control, follow-up measures on Budget pronouncements, forex rules and regulations, and a whole lot of clarifications, simplifications, etc.

Those were truly exciting times; a stroke of pen could make or mar the fortunes of various segments of the economy. New wisdom would dawn on us on half-yearly basis correcting the wrongs and thinking of new rights for the following half year. Some of it went right and some wrong and we would begin once again with a new policy, a new resolution.

All this started to change when economic crisis of 1991-92 paved way of deregulation and introduction of fiscal, monetary and banking sector reforms. The goals were clear: integrate the economy to the world economy or you were out.

Specific measures to be taken for this and the road map also became clear and transparent. We now had the collective vision of the world economic systems to lead us: Economy had to be opened up, shackles of regulations had to broken, fiscal deficit had to be controlled and economic isolation had to be avoided.

From playing to the domestic gallery, we are now the players on the world stage, waiting for an applause, a nod, an appreciation for our policies and programs from the rating agencies and economic commentators around the globe. After endless years of repression, we had to give new freedom to banks, institutions, traders, brokers, industries, and services.

The banking community which had lost power to think what is good for them by the micro management by the government and the RBI over years, had to be taught to adapt. Some did well, many did not.

Over the past few years, the credit policy has been an instrument that sets the timing and speed towards the ultimate goal: De-regulation of interest rates, bringing down preemptions like cash reserve ration and statutory liquidity ratio, integration with the world through capital account convertibility, etc. They are all steps in one direction - globalisation. Each credit policy now comes with new measures and new timetable to reach our goals.

True, the timing is still slow and the roadblocks to progress are too many. The Southeast Asian crisis has shown that all is not well with the policy prescriptions from abroad and we need to have some home grown cures for our economic ills.

It brought out starkly that we will have to hand hold our industries, banks, people and protect our sovereign right to determine what is good or bad for our country.

Bimal Jalan as the RBI governor has infused a new style of working at the central bank. Individual brilliance in policy making has given way to collective thinking process. Committees now deliberate on the speed of action, the timing, the pace of reforms.

Roadmap to economic and monetary reforms is now drawn well in advance and debated in public months ahead. Pro- and anti-reform forces have months to respond and accept changes. The veil of secrecy on policy making has lifted. The de-linking of obligations of central Bank as the controller of monetary policy and the regulator of banking system is already announced.

With each reform, the power of the RBI to determine the economic fortune of the country through changes in credit policy making is coming down. The dwindling of investments in public sector has robbed much of the power the government and the RBI had in creating jobs and impacting employment.

De-regulation of interest rates, which are now determined by banks themselves and the gradual decline in rates have curtailed the power of preference the previous governors and their credit policies had in determining costs and profits of Industries.

Holding foreign exchange is no more discouraged, forex earners are no more treated with suspicion and the comfortable reserve position makes it easier to move quickly ahead in dismantling whatever restrictions are currently in place.

Another major event that has taken place in the Jalan era is the de-linking of the economic reform measures from the credit policy.

In Alan Greenspan style, pronouncements are made from time to time through debates, speeches and changes in policies announced from time to time. True, credit policy still announces certain policy measures with all sincerity and purpose, but often it is out of habit than necessity.

The temptation to announce new credit schemes designed to make certain segments happy is too strong to totally ignore. But then, it is more often playing to the gallery, not an economic event.

No earthshaking measures are expected, no shocks anticipated, only statements of intent and a little tinkering here and there. All these make credit policy less exciting.

But this is not to say that credit policy is not a significant event. It provides a platform for review of the economic policies.

It is a time to announce the balance sheet on where we stand on various issues; time to highlight the concerns that the policy makers have, the constraints they face and bring the spotlight back on economy. If we expect too much from the credit policy, we have ourselves to blame.

Powered by

ALSO READ:
More Money Headlines