MAVERICK VIEW. The pitfalls of short-termism

A few days before the September 30, 2014 policy review, Reserve Bank of India Governor Raghuram Rajan, for all practical purposes ruled out a reduction in policy interest rates. From his point of view, it would not suffice if the consumer price index (CPI), on a year-on-year basis, fell a little below 8 per cent, that is, the objective for January 2015, but there should be a clear move towards the objective of 6 per cent by January 2016.

Such a categorical statement virtually put an end to the sterile debate by market players, analysts, opinion makers and the media on reduction of policy rates on September 30. This underscores that carefully crafted pre-policy guidance can ensure focus on the more enduring issues. The forward guidance on the policy was that future policy will be influenced by medium-term objectives, while being contingent on incoming data. In other words, the RBI policy would be firmly focused on the course of inflation.

What are the salient features of the September 30 monetary policy measures? The policy repo rate (8 per cent), the cash reserve ratio (4 per cent) and the marginal standby facility and bank rate (9 per cent) have been kept unchanged. The liquidity provided under the export credit refinance (ECR) facility has been reduced from 32 per cent to 15 per cent of outstanding export credit from October 10, 2014.

While the inflation rate in the immediate ensuing period could be well below the 8 per cent glide path for January 2015, the RBI assessment is that domestic and international imponderables could well result in a resurgence of inflation by January 2015. The RBI has shown fine judgment in not easing monetary policy on September 30. The RBI correctly feels that any relaxation of monetary policy should be contingent on the performance vis-à-vis the glide path of 6 per cent by January 2016.

As the Indian economy is increasingly integrated with the international economy it is necessary to take cognisance of a strong possibility of a sharp rise in the US interest rates. There is an asymmetry in that there is strong support for lowering policy rates but strong resistance to raising policy interest rates even when overall conditions warrant an increase.

The reduction in the ECR was long overdue and the RBI needs to be commended for its action. Way back in 1992, the Government and the RBI had committed to the Asian Development Bank that as part of the agreed matrix for the financial sector loan it would abolish this facility. In recent years, the RBI has been stressing the need to improve the monetary transmission process by emphasising the term-repo facility. While there is a need for some overnight facility, this should be provided at a higher rate. The overnight repo should be available at the present MSF of 9 per cent.

Banking and financial regulatory issues are generally addressed in the half-yearly review (September/October). While the RBI has addressed a number of vital subjects in the September 30 policy, there is the glaring absence of two issues.

(a) Inflation indexed retail certificates : The inflation-indexed certificates for retail investors linked to the consumer price index were to be revamped in the current financial year. The entire first half of the financial year has gone by and yet the revamped scheme has not been issued. Such schemes cannot be successful if the scheme is on/off; investors need the assurance of such schemes being available through the year. Moreover, there is merit in making the interest on this scheme free of income tax, but only up to a ceiling of ₹100,000 of income. To ensure that the scheme is not misused, the tax-free status should be provided only to taxpayers who have a PAN card and all agents for the scheme should be required to set out the interest paid out under Form 26 AS for total amounts over ₹10,000.

While there is merit in not widening the tax-free status, it is paradoxical that the Government provides tax-free status for company dividends and public sector bonds but denies itself such benefits on its own instruments. The question of granting tax exemption to individuals investing in government securities has been discussed for 20 years, yet each time the revenue experts shoot down the suggestions of the economic wing of the ministry of finance!

(b) Cartelisation of the savings bank interest rate: There is a long history of cartelisation of interest rates by banks. When lending rates for the general category (that is, other than items considered as priority) were deregulated, all banks followed the erstwhile regulated rate. The RBI had then cautioned banks that this would be considered as cartelisation.

Accordingly, each bank fixed its own rate. In the more recent period, after the deregulation of the savings bank deposit rate, all public sector banks and large private sector banks are following the erstwhile 4 per cent regulated rate; only a few small private sector banks have offered higher rates. This works against small depositors. The ruse used by banks is that small deposits are costly for banks — so much for financial inclusion. Time and again it has been articulated that this is an obvious case of cartelisation. The only option seems to be for an amicus curiae to move the courts. The RBI, the Competition Commission of India and the Indian Banks’ Association will be well advised to take action before regulators are hauled over the coals for dereliction of duty.

The writer is a Mumbai-based economist