RBI rupee package: the big picture is important

By C. R. L. Narasimhan

Does the recent Reserve Bank of India's rupee support package impact upon the government securities market and if so how? Experts will say that the connection is obvious and that the RBI's action will jeopardise the Government's borrowing programme. Lay people however, need to appreciate this connection as well as several other linkages in the financial sector.

By the same token it is incumbent upon the policy establishment - whether the RBI or the Government - to educate the public at large. So in the instant case, along with announcing a Bank Rate /CRR hike, the RBI should have elucidated - through the same press release maybe - the rationale of the package and its likely consequences on the rest of the financial sector. Only then can monetary management and by extension macro-economic management be better appreciated. And, if a better awareness is brought about, most of these esoteric issues will get demystified. And that would be to the benefit of all.

The financial sector's constituents are not yet fully integrated in India in the way they are in the developed countries. But the integration is happening faster than is apparent to most. Already, the happenings in the financial markets - the government securities market, the money market and the foreign exchange market - establish the growing interconnection among them. Signals emanating from one sector get transmitted across the system, although not with the same degree of efficacy as in the developed countries. Nevertheless, even at their present state of development valuable clues regarding the future direction of monetary policy can be had. These can be illustrated with an understanding of the connection between the recent Bank Rate hike and the government securities market.

Narrow but misleading view

To relate the Bank Rate hike (along with the CRR increase and a 50 per cent reduction in the refinance limits) to an imminent increase in the interest rate structure is a pedestrian approach. Not surprisingly that is how many have viewed the recent RBI package and criticised it roundly. It would make bank credit to industry scarce. Borrowers will have to bear a higher interest burden.

There are however weightier issues beyond the single point interest rate agenda so assiduously projected by the chambers of commerce, industry associations and other vested interest groups. While - for the record - the public sector banks, bowing to pressure, have not so far hiked their prime lending rates, it remains to be seen how much longer they can hold out in the face of market developments.Needless to add the Bank Rate variation is the classic signalling device. This time the RBI has increased it by one percentage point. Along with the other RBI measures announced recently, that would indicate monetary tightness. Although industry sources claim that they are the only victims, knowledgeable sources point to the big picture.

Government borrowing, the casualty

A more serious and deleterious impact will be felt on the Government borrowing programme. For this year it has been budgeted at Rs.117, 000 crores. At the start of fiscal 2000-01, the RBI and the Government were confident: inflows into the market by way of previous debt redemptions were estimated at nearly Rs.85,000 crores leaving only a gap of Rs.32,000 crores or so to be met by banks, mutual funds and the like. Bank deposit growth has been projected at 15 to 16 per cent.

The inference clearly has been that the system was liquid enough to accommodate the government borrowing as well as the increasing credit needs of industry. The Central bank has now targeted excess liquidity implying that rupee - destabilising speculators have had access to the rupee funds. That will obviously place big question marks over earlier assumptions regarding the government debt programme during the rest of the year.

Normally more than half of the government borrowing is completed during the first few months of the fiscal year - the traditional slack season. The logic is that during the latter half industry would demand more of bank credit and if the Government also happens to be in the market at the same time, there will be the ``crowding'' out effect to the detriment of corporate borrowers.

Unfortunately this year, only about 45 per cent of borrowings has been completed and for the remaining the Government will be facing increasing competition with industry. Most of the projected inflows are expected to materialise during the early part of the year. So even if there was no liquidity crunch, there could have been a problem of temporary mismatch. Add to this the likely consequences of the RBI action and the government borrowing programme can run into rough weather. Even before the recent hike in the Bank Rate, the market has been expecting higher yields from gilts. Now the sentiment has turned worse. As against the central bank's objective of increasing the maturity profile of government debt, indications are that it has been reduced this year. The latest interest rate changes will make banks and other institutional investors wary of long period investment. Monetisation of debt - the net RBI credit to Government - will increase.

All banks have invested heavily in government securities, often far more than what is required of them. Any interest rate hike pushes down the value of those investments. Besides, for them to mop up more deposits (to fund both industry and government) they may have to offer more to the depositors. If industry has causes to complain, the Government has more reasons to be worried. For the near term, however, the RBI seems to prefer a stable rupee to uncertainties on the interest rate front.

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Section  : Business
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