Monetary Policy: style and substance

By C. R. L. Narasimhan

While the general contours of the recently announced Reserve Bank of India's Monetary and Credit Policy are well known, its nuances are probably not that easily noticed. For instance, what is the broad thrust of the policy? Stressing stability and continuity in its medium term goals, the RBI prefers a flexible approach in the short-term. But there is no dichotomy here. Deliberately the operational, ``spectacular'' details of monetary management have been separated from the policy.

There could be two reasons for this: First, to lay people it is only the operational aspects, be it a Bank Rate cut or a cash reserve ratio reduction, that could be of some interest. Even bank customers - exporters, borrowers and depositors - may not comprehend the more technical aspects of the monetary policy. And, of course, all the hype is built around an interest rate reduction or an easing of liquidity. Lobbyists too clamour only for those. It is the RBI's intention to remove those distractions even while it pursues medium term goals, including financial sector reform.

Second, the short-term monetary measures can be and in the recent past have in fact been used as and when required. Indeed the results flowing from an unexpected Bank Rate hike or a CRR reduction are often better than when they are anticipated. Moreover, exigencies - sudden liquidity strain or creeping inflation - demand immediate action and cannot wait for the policy announcement dates.

Under the present Governor, Dr. Bimal Jalan, the RBI has been deliberately pursuing the above strategy. In many ways this has brought about greater transparency. With no ``exciting'' announcements possible, the annual policy statement is sometimes dubbed a non-event. Which, of course, it is not. Of the several topical issues covered by the policy statement, the most urgent one is - once again - the strident warning against fiscal mismanagement. The RBI's lucid commentary on the fiscal situation is also an elaboration of the interdependence between the fiscal and monetary policies.

The major worry

The high level of fiscal deficits continues to be a major problem. According to the revised budgetary estimates, the fiscal deficit of the Central Government (excluding small savings ) was higher at 5.6 per cent of the GDP as against the budgeted 4 per cent.

The RBI, for long a strong votary of reining in government spending, has spelt out the adverse consequences. There has been a sharp increase in repayment obligations on account of public debt. In 1990-91, gross and net borrowings of the Central Government were in the ratio of 1:0.89. This means that for every one rupee of fresh borrowing the Government received 89 paise. In 2000-01 the gross and net borrowings are projected at Rs. 117,704 crores and Rs. 76,383 crores respectively. This means that in the current year for every rupee borrowed afresh the Government will get only 65 paise. Naturally interest payments have ballooned to an estimated Rs. 101,266 crores, more than 4.7 times the figure for 1990-91.

The impact of all these on the monetary aspects needs further elucidation. Obviously, market borrowings by the Government have gone up. Last year they exceeded the budgeted level by Rs. 15,616 crores. Naturally, the monetary management came under stress. The RBI says that due to the favourable macro-economic environment it was able to meet those large requirements last year without much stress and without putting pressure on the interest rates. On its part, the RBI also took some proactive steps such as elongating the maturity structure of debt. Second, through successful open market operations, it managed to keep the growth in net RBI credit to Government at negative levels.

Nevertheless, the large borrowings have put pressure on the absorptive capacity of the market. The banking system now holds government securities far in excess of what regulators expect of it. In terms of volume, the holdings above the statutory liquidity ratio (SLR) are now around Rs. 85,000 crores which is higher than last year's net borrowings. The banking system now holds government securities of around 34.3 per cent of their net demand and time liabilities as against a minimum statutory requirement of 25 per cent.

The RBI pertinently observes that given the increasing complexity of monetary management, last year's achievement in containing the deleterious effects of the large borrowing programme could only be termed as fortuitous. There were no inflationary pressures last year or problems of excess demand. If these had existed the interest rates would have gone up substantially and private investments would have been crowded out to a degree. A vicious cycle of tight liquidity and high interest rates would have emerged. Especially while guiding the interest rates, the debt management function has become an integral part of monetary management.

The RBI does not think that it is desirable to separate debt management from monetary management. However, a debate on those and related issues will hopefully continue.

Though devoid of excitement, the monetary policy is illuminating. For example, last year's success in completing the large government borrowing is due as much to deft handling as to fortuitous circumstances, which cannot be taken for granted.

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