Easy liquidity, softer interestrates high on agenda

WHEN THE Reserve Bank of India (RBI) meets for the customary mid-term review of Monetary and Credit Policy 2001-02 on October 22 at probably the most difficult time in the global economy as well as in the domestic economy, the policy will continue to place emphasis on easy liquidity conditions and softer interest rate regime as it spelt out in its annual policy in April this year.

Further it will continue to place its concern on the current fiscal situation and ask for greater fiscal responsibility from the Government. Also the policy is expected to review the monetary measures, like, Bank Rate, repo rate and Cash Reserve Ratio (CRR).

``The possibility of a cut in the Bank Rate around the time of the monetary policy is a reasonable expectation'', said Mr. Srinivas Varadarajan, Co-Head, Foreign Exchange, J.P. Morgan.

However, the Reserve Bank is dragging its feet to reduce the domestic interest rate in line with the co-ordinated rate easing by major central banks around the world to ward off the likelihood of a global recession, in the aftermath of terrorist attack in the U.S. ``But the go-slow attitude adopted by the central bank is understandable,'' said Mr. N. Subramanian, Consultant, eMecklai, a leading foreign exchange dealing firm. According to him the central bank is torn between its economic compulsions and the government's political sensitivity.

The regulated interest rates for the government's small savings scheme need to be fine tuned in line with the market situation before it can act on the monetary policy. Though the present industrial slowdown in the domestic economy might warrant an interest rate easing, the central bank's current dilemma is likely to persist. The bank needs to weigh the politically sensitive issues of withdrawing tax sops or reducing interest rates on small savings.

``In so far as Bank Rate is concerned, much as the RBI may want little or no comparison with the U.S. Federal Rate and the rates in other developed countries, the compulsions for such a comparison arising out of demands from the entire financial community seem to be far too strong to be ignored,'' said Mr. M.S. Annigeri, Executive Vice-President, ICICI Bank.

The Finance Ministry too has been giving subtle hints about lowering interest rates. The RBI on its part may express its desire for a greater fiscal discipline on the part of the Central and State governments. ``But at the end of the day the cut in Bank Rate by at least 50 basis points seems inevitable,'' Mr. Annigeri added.

However, the cut in interest rates is likely to impact adversely the retired population, who depend solely on the interest income for their living especially those who have not bowed out of a government job with indexed pension benefits. Some of the government's savings scheme like Indira Vikas Patra and Kisan Vikas Patra are more often offers tax-free investment opportunities to ill-gotten money.

Said Mr. Subramanian ``The government should reform the entire tax structure, so as to remove the tax sops and instead charge a nominal tax - say 5 per cent on interest income from such savings scheme. And as a measure of protection to the retired persons, they should be given exemption up to some limit, on the principal amounts.

The bank should avoid blindly reducing interest rates to fulfil a temporary economic need.'' The removal of tax sops would bring down government's borrowing and put less pressure on the interest rates and would eventually lead to better management of inflation threats.

The government should have a fresh look at the existing foreign exchange policy of regulated and regular depreciation of the Rupee vis-a-vis the U.S. dollar either to match weakening currencies of its trading partners or its competing countries. The weaker domestic currency invariably leads to higher cost of imports and since crude oil and other petroleum product forms bulk of its imports, it causes a cascading effect on the general price line.

Moreover, the sops for exporters have not had much impact on the domestic economy, as the export basket of the country has remained rather unchanged over several decades. The higher inflation arising out of arbitrary depreciation of the rupee justifies further depreciation of the domestic currency for adjusting the inflation differentials.

Thus the rupee is in a vicious cycle of constant depreciation and it is almost a wonder that the Indian economy has sustained such an onslaught on its currency, Mr. Subramanian felt. The above policy has almost created a parasitical growth of inefficient industries, which had drained scarce resources of the nation and have deprived regional development. If the technological advancement by India is not hyped, India's participation in the ongoing technological revolution should ensure exports growth to the New World and make its present exchange rate policy redundant. It is time that India transforms from primary product to a distinguished technology exporter.

There would be no need for competitive devaluation of the domestic currency to promote exports, which might even lead to lesser tax evasion. There is an urgent need to address this issue by the central bank in its review of monetary policy.

Along with the Bank Rate, the repo rate is also likely to be brought down but this may be announced outside the monetary policy, the purpose being to indicate that the change in repo rate is a shorter term signal and not in the nature of a medium or long term signal. As far as CRR is concerned, although no immediate cut may be announced given the overhang of liquidity in the system, a broad road map for reduction of CRR may be spelt out in keeping with the medium term objective of the RBI, to bring down the level of mandatory preemptions, so as to allow a greater share of the resources of the banking system to the productive segments of the economy. According to Mr. Annigeri, the policy may also contain comments on the steps proposed by RBI to amend the RBI Act itself in so far as the minimum prescription of 3 per cent CRR is concerned.

Universal banks

The issue of financial institutions desiring to be converted into universal banks might also be addressed. The review of monetary policy will also touch upon measures to improve the infrastructure for debt market. Further, a time frame in which real time cross settlement system may be put in place might also be addressed.The RBI is also expected to take a hard look at the industrial slowdown, progress related to infrastructure and NPA figures of banks. In so far as non-performing asset (NPA) problems of banks are concerned, RBI may ask the banks for a definite plan of action for bringing down the NPAs to reasonable levels.

The apex bank may also look at measures that would be taken to make the Debt Recovery Tribunal (DRT) more effective in recovery of bad debts. In its policy the RBI may also announce that certain special measures to address the problem related to the development of infrastructure.

One of the possible steps could be to include infrastructure financing under priority sector. This could help achieve the twin objective of funding infrastructure requirement as also helping banks achieve priority sector targets.

OOMMEN A. NINAN

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