The Reserve Bank of India (RBI) is, by its position as central bank, the guardian of countryâ€™s banking sector. With the help of suitable monetary policy instruments, it manages and directs the various financial institutions of the country so that there is neither shortage nor over supply of various components of money in the economy. It sees to it that there is neither deflation nor inflation. Thus from time to time it announces the shape and broad contours of the credit policy for months to come. Generally, it does this every six months though it can also make changes any time if the situation so demands.
Every undergraduate student of economics is familiar with both quantitative as well as qualitative instruments of credit control and money supply at its disposal. The former consist of bank rate, open market operations, cash reserve ratio, and statutory liquidity ratio, while the latter include moral suasion, warnings and directives. With the onset of globalization serious doubts have been expressed about the efficacy of these policy instruments and the effectiveness of the RBI in controlling money supply and inflation. We shall come to this after a little while.
On October 25, 2005, the RBI looked into the state of Indian economy during the six-month period covering April-September 2005. It was happy to note that the rate of growth of GDP was encouraging and it hoped that the overall rate of growth of GDP would turn out to be 7 to 7.5 per cent during 2005-06. There were positive signs of satisfactory progress in all the three sectors, namely, agriculture, industry and services. This was reflected in growing self-confidence of the business world and increasing inflow of both the foreign direct investment, and foreign institutional investment, indicated by some sort of boom in the capital market.
In view of this state of the Indian economy, the RBI did not think it necessary to alter the quantum of money supply in the economy. Thus it left bank rate, cash reserve ratio and statutory liquidity ratio unaltered. The reverse repo rate only was raised from 5 to 5.25 per cent. It, however, appeared worried at increasing rate of inflation. At present the rate of inflation is more than 4.5 per cent, but apprehension is that it may soon cross the five per cent mark. In the present era of globalization, it is not easy to control the level of inflation with the help of monetary policy instruments. Why?
Every student of economics knows that inflation has two components. The first is core component, which solely depends on the balance of supply and demand of goods and services, the quantum of money in the economy and the perception about the future. This component can be, to a large extent, controlled by the central bank with the help of monetary policy instruments and by the government through administrative measures like dehoarding and regulating the distribution of goods and taking action against blackmarketeers and profiteers.
It is not, however, possible for the central bank and the government to control inflationary pressures if the economy is heavily dependent on imported inputs of production and consumer goods. In the era of globalization, it is not possible for any national government to erect tariff barriers and adopt administrative measures to stop the inflow of foreign goods.
So far as the Indian economy is concerned, in recent years the price of imported crude oil has increased manifold and it may continue climbing up in the months to come. The RBI governor Dr. Y. V. Reddy has himself admitted his inability to check this component of inflation due to increasing import of oil. It is needless to add that this is going to push up the cost of production as well as that of distribution of goods and services. As public transportation is neither adequate nor reliable, people will not give up the use of private vehicles. Nay, in the coming months the number of private vehicles is going to increase because that segment of the society that demands has no dearth of money. There is a plenty of money both black and while at its disposal. Banks are ready to finance the purchase of vehicles at relatively easy terms and in the months to come more and more automobile manufacturers are to place their cars in the market. Then there is â€œdemonstration effectâ€ too. The fashion of small cars like Maruti 800 seems to be on its way out and the buyers are going in for larger cars that consume more petrol.
According to The Economist (October 22), â€œStephen Roach, chief economist of Morgan Stanley, suggests that thanks to globalisation, the inflation process has changed over the past three decades in a way that has significantly weakened the link between the domestic cost pressures and inflation. He draws on an analysis in the latest annual report of the Bank for International settlements (BIS), which suggests that global forces have become more important relative to domestic factors in determining inflation in individual countries.â€
So far India is concerned, during the first half of the current year the total import bill came to $63 billion of which oil component was $21 billion. It needs to be noted that oil bill showed an increase of 43 per cent. Till now the government has resisted the passing of the full incidence of oil price increase onto consumers and this has slowed the fury of inflation but it will not be possible for the government to do so if the price of oil continues its upward march.
There is another fact that weakens the efficacy of the RBI and its policy instruments to control the quantum of money supply. The prevalence of credit cards for making purchases both internally and externally has added to the money supply and, as the time passes, its role in aggravating inflationary pressures will become more and more evident. It is not wrong when John Ralston Saul in his recently published book The Collapse of Globalism and the Reinvention of the World (Penguin, 2005) says that with the onset of the present era of globalization â€œWhile central bankers remained concerned about classic monetary levels, the private sector was printing however much money it wanted through a broadening set of private mechanismsâ€”from junk bonds to credit cards.â€ (p.144)
It seems the RBI is aware of the declining efficacy of the traditional monetary policy instruments. It is thinking of reducing the number of policy instruments and increasing the effectiveness of the policy instruments that remain. In view of the success of its â€˜liquidity adjustment facility,â€™ it is hoped that in future its emphasis will be more and more on controlling and regulating the money supply in the short run and encouraging domestic production so that the impact of imported inflation may be reduced. At the same time, as Governor Dr. Y. V. Reddy has emphasized, the RBI will give adequate attention to the quality of credit. He admits the need to review the pricing of credit, i.e., fixing the rate of interest. He wants a detailed thoroughgoing analysis of the need and cost of credit at various level of production. He is aware of the widespread belief that banks discriminate against agriculture and small and medium scale enterprises in the matter of quantum of credit and the rates of interest charged from them. While higher rates of interest are charged from them, more favorable treatment is given to large industrial enterprises. The governor has assured that he would ask the organisation of Indian commercial banks to look into the matter and make appropriate recommendations.
The emphasis by Reddy on greater mobilization of deposits may not succeed if the rate of inflation goes on climbing the interest rates on demand and time deposits remain unchanged. Existing and prospective depositors may invest greater portions of their savings in bullions and immovable property.
In the end, it seems the RBI is not at all serious about the problem of non-performing assets with which most commercial banks are saddled. There are two aspects of the problem, first, from now onwards the phenomenon of NPA must not be allowed to arise and, second, ways and means must be found to recover the outstanding from the defaulters. Let us hope, the RBI will do something worthwhile in the months ahead.