ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Macro Perspective A Refreshing Change

Monetary and Credit Policy THE latest monetary and credit policy announced by the RBI on April 29 in respect of the first half of 1998-99 seeks to make a significant, even if guarded, departure from the earlier policy stance. To begin with, there is the noteworthy admission that the analytical framework underlying monetary policy hitherto, which has accepted the stability of the money demand functions as its cornerstone, requires rethinking. Though the RBI governor's statement singles out recent financial innovations as the cause for this reconsideration, sufficiently strong reasons for adopting an eclectic approach to the formulation of monetary and credit policies as suggested now had already existed. The bi-directional nature of the relationship between money, output and prices had been long recognised and the monetary character of inflation ingrained in the existing framework questioned. The influence of the level and structure of interest rates on money demand has been a proven factor now for over two decades. "A striking aspect of credit policy in 1974-75 was the emergence of interest rate as an important instrument of monetary management"; so had said the RBl's Annual Report for that year, more than 20 years ago. Despite the interest rate weapon being effectively deployed from time to time, its use in the RBl's thinking on policy framework has generally fallen by the wayside during the past decade or so, essentially because of the dominating influence of monetarism. Such a blinkered approach to monetary policy formulation hitherto had prevented the authorities from seeking a more positive role for money and credit in the development process. Therefore, the promise now made by the RBI governor to look for a wider set of indicators from the domestic financial and foreign exchange markets, including credit movements, juxtaposed with output and other real sector data, should open up a new and welcome path. A second refreshing change is seen in the importance given to institutional and structural features of the financial system rather than the focus being on such broad macro numbers as M1 and reserve money and their relationships. That such a fresh thinking was in the offing was evident from the appointment of three committees by the new RBI governor immediately on taking charge-two one-man committees for studying credit delivery inagriculture(R V Gupta) and small-scale industries (S L Kapur) and a working group of chairmen of commercial banks and development finance institutions(DFIs) under the IDBI chairman S H Khan on harmonising the regulatory environment for banks and DFIs. The observations contained in the RBl's credit policy statement in respect of these areas - though not many policy decisions have been formulated as yet bring out the freshness of thinking that is being brought to bear on the whole financial sector policies; the proposed reforms in the financial sector are being carefully crafted. For instance, the preference expressed by the authorities hitherto has been to rapidly move towards the concept of Universal banking' and abolition of the distinction between banks and DFIs. But the RBI governor's latest policy statement puts forth significant words of caution and promises a ''discussion paper" setting out the RBI's draft proposals "for bringing about greater clarity in the respective roles of banks and financial institutions and for greater harmonisation of facilities and obligations applicable to them". In the case of institutional credit for agriculture, the emphasis would be on simplification of delivery mechanism and a substantial reduction in paper work, The question of strengthening of institutions for rural credit, which is a crying need of the hour, remains however to be addressed.

Ample Liquidity, but No Pick-Up in Investment

in Investment The financial markets were marked by an abundance of liquidity throughout 1997-98, even though funds deployed by banks in non-food advances and commercial investments picked up in the latter half of the year. So did disbursements by the term-financing institutions. The injection of liquidity seems, however, to be getting absorbed in higher inventories and, on the supply side, in substitution of capital market funds, Effective investment in the economy, in manufacturing and infrastructure in particular, does not appear to be picking up.

Fiscal Impetus Missing

Fiscal Impetus Missing The economy is facing a serious structural constraint Public sector investment, which crowds-in private sector output and investment, has suffered badly. Private sector companies are not in a position to raise fresh equity as the share market is in the doldrums. Fear of non- performing assets and capital adequacy requirements is hindering banks and financial institutions in extending credit to industry. In such a situation, decisive action on the fiscal front alone can break the impasse.

Fire-Fighting on Policy Front

Fire-Fighting on Policy Front Instead of operating on their long-term policy mandates, apex institutions such as the RBI SEBl and IDBI seem to concentrate on immediate, short-term issues. This distortion of the perspective of policy-making is embedded in the type of liberalisation of the financial sector and the foreign exchange market that has taken place.

Reversal of Premature Policies

Reversal of Premature Policies Developments in the domestic financial markets against the backdrop of the turmoil in the south-east Asian markets have punctured the claims of the authorities that India's economic fundamentals were satisfactory and that we could open up the external sector further leading soon even to capital account convertibility. Therefore, if the new governor of the Reserve Bank has been introducing measures retracing some of the steps earlier taken prematurely and not as a natural consequence of sound fundamentals, he has strong reasons for doing so.

Fundamental Distortions Persist

EPW Research Foundation Fundamental Distortions Persist Recent RBI policy measures, suggesting a reversal of the liberalisation path, are a welcome attempt to curb speculation in the domestic foreign exchange market But they have failed to address the fundamental distortions that have been created in the financial system.

External Destabilisation Early Warnings

EPW Research Foundation The money, foreign exchange and capital markets have witnessed skirmishes, reflecting the south-east Asian turmoil While the general impression that Indian markets are by and large insulated from external turmoil is valid, there is no gainsaying that both the stock markets and the exchange rate are under pressure. This is largely because of poor domestic fundamentals, but partly also because of the destabilising effects of the liberalisation process.

Government s Debt Profile Getting Distorted

EPW Research Foundation Government's Debt Profile Getting Distorted Policy Distortions IN the first week of September, the Reserve Bank of India (RBI) released its Annual Report for 1996-97 which has set out certain noteworthy statements relating to the evolving nature of the money and financial markets. In doing so, however, the central banking authorities seem to have ignored the series of macro and micro level distortions that have crept in as a result of the somewhat forced pace of changes in fiscal deficit and the government's debt profile. First, the authorities have failed to notice that excessive fiscal compression has hurt the process of industrial growth, the results of which are also seen in an extremely poor bank credit offtake now for over 18 months and excess liquidity in the financial system. Even against the back ground of serious demand constraints faced by the Indian industry, the R BF reiterates the same 'mantra' of the need to reduce the centre's gross fiscal deficit further from 5 per cent of GDP in 1996 97 to 4.5 per cent in the current year. Second, despite a steady decline in the central government's debt to GDP ratio, the RBI's annual report talks of a growing size of debt. The centre's internal debt to GDP ratio has fallen from 303 per 98 (RE),total internal liabilities to GDP ratio

Exchange Rate Tremors

EPW Research Foundation Exchange Rate Tremors An important lesson to be learnt from the recent exchange rate developments is that the situation would have been much less amenable to control had the scope for speculative operations been as ample as it is in, for example, some of the south-east Asian countries. Fortunately, the regulations relating to remittance of export receipts and the limited nature of hedging instruments, combined with the controls on capital outflow, have helped to moderate the exchange rate tremors.

Government Main Gainer from High Liquidity

EPW Research Foundation While the benefits of the abundance of liquidity, which remains the dominant feature of the financial markets, have been marginal to the commercial sector, the government has taken full advantage of the situation to nearly complete its full-year borrowing programme within the first five months of the financial year.

In Pursuit of Lower Interest Rates

EPW Research Foundation In Pursuit of Lower Interest Rates The RBl's announcement, on June 25, of a one percentage point cut in the Bank Rate came as a surprise to the market. The authorities are using the lower interest rate route to induce a pick-up in commercial bank credit.

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