Interesting linkages

THE FINANCE MINISTER'S concern over the recent sharp depreciation of the rupee against the dollar and his earlier direction to government-owned banks to reduce their level of non-performing assets in a time-bound manner are not to be viewed as narrow sector-specific problems. They ought to be seen from the larger macro-perspective of an economy whose different constituents are fast getting interlinked with one another and where, as a consequence, the signals from one sector get transmitted across the system. The latter approach alone will ensure a meaningful understanding of specific issues and provide realistic solutions.

It follows that official policy will have to address several economic issues simultaneously. It would be unwise, for instance, to ignore the happenings on the interest rate front. A combination of factors is set to push up the rates, thereby reversing the trend that set in a few years ago. The forecast of a higher interest regime might be particularly disappointing to many because as recently as in April this year the goal of achieving an internationally competitive regime appeared tantalisingly close. At that time the RBI lowered the bank rate and sent other signals to the market. But not all banks responded, with the majority hedging their bets. Clearly, previously controlled economic variables such as the interest rate and the exchange rate now take their cues from the market- place rather than from official proddings.

The causes underpinning the interest rate are noteworthy also because they explain the other economic concerns. Inflation, after a period of decline, is back in the reckoning, almost entirely because of an increase in the administered prices. The forecast of yet another good monsoon might minimise the supply- side inflationary sentiment but from a monetary perspective major dilemmas remain. The stance of the RBI's monetary policy has always been to maintain price stability while ensuring that the genuine needs of the industrial sector are met. All available data point to a mismatch between the expected demand for and supply of funds. The ongoing industrial recovery will make large demands on banks, by as much as Rs. 11,000 crores more than last year's credit utilisation of Rs. 69,000 crores. The Government is also expected to borrow at least Rs. 31,000 crores more than it did last year. As Mr. Yashwant Sinha has cautioned yet again, fiscal reform including a cap on government spending and borrowing is a vital necessity over the medium-term. However for now the prospects of public borrowing aggravating the already tight liquidity conditions look very real. Interest rates can only go up. The connection with exchange rate stability is obvious in that scenario. To check the rupee's further decline, the RBI, which has already clamped a stiff surcharge on importers and penalised exporters who delay their remittance, might intervene more overtly by selling dollars. Domestic liquidity will be further strained. Besides, in a fast globalising scenario there has to be an interest parity among nations. Interest rates in the U.S. are on the upswing and the expected global flight of funds into dollars cannot be ignored by the RBI. Equally obvious is the connection between interest rates and the cleaning up of bank balance sheets. The high level of non-performing assets has been a major obstacle in the way of a flexible interest rate regime. Interest rate tidings explain many concerns of the day.

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