Escaping the inflation squeeze

The odd thing about what the government and Reserve Bank have been doing to fight inflation (and this was pointed out to me by Pronab Sen, a seasoned economist who is now the government's statistics czar) is that North Block and Mint Road are busy trying to make bank credit more expensive and less easy to get, while at the same time encouraging companies to borrow more money overseas.

The first set of steps is meant to tighten the screw, so as to reduce money supply in the market; the second does the opposite by allowing companies to borrow overseas and bring that money into the country. The first is designed to slow down the business tempo, the second facilitates it. So what exactly do the government and RBI want?

The numbers are interesting. The ever-resourceful B G Shirsat of the Business Standard Research Bureau has worked out the money borrowed from the commercial banks by 2,569 companies listed on the domestic stock exchanges; the total is a little over Rs 1,70,000 crore.

And what is the money borrowed overseas by way of external commercial borrowings? The total works out to $32 billion, which is about Rs 1,44,000 crore. The numbers are uncannily close. It is possible that the two numbers should not be directly compared with each other (the overseas borrowings could be partly by banks, which then lend to their domestic customers).

But it does make one other comparison interesting, which is with the figure for total bank credit  -- around Rs 20,00,000 crore. In other words, the listed companies account for less than 9 per cent of total domestic bank credit. So when you read those reports of the big corporate names borrowing impressive billions overseas, you know exactly what they are doing -- escaping the RBI's net.

That raises the question -- where does 91 per cent of domestic bank credit go? The answer is that it goes to smaller, unlisted firms; to the vaunted millions of middle-class consumers who are buying cars and houses on borrowed funds; to the farmers and small businesses who have no option but to go to the banks.

Even among the listed firms, much of the external borrowing is by the biggest of the lot, because it is they who have the size and expertise and reputation to go offshore and get funds. The smaller of the listed companies (and the median listed company, ranked by size, has a sales turnover of less than Rs 100 crore) are borrowing money purely domestically.

So who gets hit by the Reserve Bank tightening monetary policy, and by higher interest rates? Why, the small and medium businesses, retail customers and all the chaps clubbed under the 'priority sector' category: farmers, truck owners, traders, petty shopkeepers, and such.

The big guys have access to funds overseas, and their cost of borrowing does not change at all. If anything, a tighter domestic monetary situation gives them a comparative advantage when it comes to the cost of borrowed funds.

So the smarter banks have stopped chasing the big companies in the hope of lending to them. These companies have direct access to the money market, and when they do borrow from the banks, they expect to get rates that are a good 3 percentage points lower than the prime lending rate, so the banks don't make much money on that business.

Far better for the banks to seek out smaller companies and other customers who are willing to pay higher interest rates because don't have the same level of choice when it comes to sources of funds.

But if the government were to shut the window to overseas finance, forcing even the big companies to tap the domestic money market, that might make matters worse because the big fish will now be competing with the small fish for the same pool of domestic resources -- and that could make money even more costly for the latter. But while doing that, it would have the merit of making the RBI's monetary tightening more effective as a policy stance.