No optimism on interest rate front

By C. R. L. Narasimhan

The mid-term review of monetary and credit policy for 2000-01 announced on October 10 has, as expected, few surprises. That is entirely understandable. Since end 1997 the Reserve Bank of India has been consciously delinking the more eye catching operational measures from policy announcements.

However, even while the mid-year review is true to form, it has invaluable material on key issues of monetary and economic policies.

The interest rate scenario will always remain high up on the central bank's dissertation. More than any other economic variable the interest rate issue fascinates one and all though not for the same reasons.

Officially, the RBI favours a general lowering of interest rates. But in an increasingly deregulated environment the central bank alone cannot bring about the desired change. After all, nowadays commercial banks and not the RBI fix the benchmark prime lending rates. The central bank has on more than one occasion explained the reasons in great lucidity.

What is the central bank's thinking on the future direction of interest rates? Even from a statement which, true to form, has left the major interest rate signalling devices untouched - a few clues can be had:

One, the RBI has lowered its forecast of the real GDP growth during 2000-01 to 6-6.5 per cent from its April forecast of 6.5-7 per cent. This would indicate that the monetary authority may favour assorted stimuli including lower interest rates to prop up growth rates.

Two. However, as always, the RBI has to reckon with inflation. On a point to point basis, the rate of inflation was 6.06 per cent on September 23 as compared to 3.20 per cent a year ago. On an average basis the annual inflation is up at 4.96 per cent against 4.37 per cent last year. Comparisons based on consumer price indices (CPI) may show mixed trends: in August, inflation so measured was 3.99 per cent as compared with 3.15 per cent in August 1999. If the CPI inflation indices are averaged however, they show a lower trend now.

The crucial factors in inflation are the oil shock and the demand/supply situation of other sensitive commodities. In RBI's view the outlook on the latter is comfortable. The rate of inflation for the rest of the year is likely to be close to the average of the last two years, it says.

Three, the monetary expansion so far this year has been on course. On a year-on-year basis money supply grew by 6.6 per cent up to September 22, 2000 as against 6.8 per cent last year. M3 growth is expected to remain around 15 per cent for the whole year within its budgeted range.

Four, banks have mobilised more deposits at Rs. 59,603 crores as compared to Rs. 51,680 crores during the same period last year. They have also lent more, with non-food credit growing by 6 per cent (Rs. 24,649 crores) so far this year as compared to just 2.3 per cent last year.

The RBI estimates that the total resources flow to the commercial sector (including capital issues, GDRs and borrowings from financial institutions) increased by Rs.58,838 crores this year as compared to Rs.34,325 crores last year.

The increase has occurred despite some signs of deceleration in industrial output in recent months. The need for cheaper credit may be articulated with greater emphasis in the coming weeks by industry-level organisations and chambers of commerce.

However, past experience tells us that a further reduction in bank lending rate, even if possible, may not by itself reverse the declining trend in industrial production. The RBI has of course paid attention to improving the credit-delivery system and to specific sectors such as exporters.

Five, for interest rate prognosis the fiscal situation obviously matters. The Union Government's fiscal deficit up to August is significantly lower by more than 24 per cent as compared to last year.

A substantial jump in revenue receipts (27.5 per cent) and a marginal rise in expenditure have helped.

However, two major uncertainties remain: there will be a greater allocation from the budget to fund the oil pool deficit. Secondly, the disinvestment target for the year (Rs.10,000 crores) looks elusive yet again.

Six, Government borrowings have a direct impact on interest rates. Up to the first week of October, the Central Government has completed Rs. 77,183 crores of gross borrowings out of the budgeted Rs. 117,704 crores.

The RBI urges once again to keep the borrowings within limits. ``In fact'', says the RBI ``a reduction in the borrowing programme would be desirable as it would make a positive contribution to keeping the interest rate outlook positive and stable''.

Seven, the state of the external sector has a major bearing on domestic interest rates. Since the middle of May this year external sector management has proved to be complex. The rupee has declined sharply against the dollar (3.2 per cent between May 31 and September 29,) and overall foreign exchange reserves have declined by $1.8 billion. There has been a general hardening of interest rates in the U.S. and European countries recently.

This reduced the interest differential between the rupee and the dollar is making dollar investments even more attractive. Besides, the confidence in the American economy continues unabated.

Although the RBI has hiked the bank rate and tightened liquidity conditions to partially offset this development, it may have to keep such options open. Especially because the oil shock is now being felt across the economy.

Even in the Annual Policy statement, the RBI had warned that ``the outlook can change dramatically within a relatively short period of time in the event of unanticipated domestic or international events''.

It therefore reserved the right to tighten monetary policy through the use of instruments at its disposal when necessary and unavoidable.

The interest rate outlook depends crucially on external market conditions, domestic developments in respect of the overall rate of inflation, demand for credit from the commercial sector and the Government's borrowing programme. The RBI says that it will endeavour to maintain a stable interest rate environment.

But contingencies may upset the most detailed calculations. And force the RBI to tighten the monetary measures. No one is going to bet on a lowering of interest rates.

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