Governor Raghuram Rajan’s third bi-monthly monetary policy 2014-15 on August 5 was appropriately cautious given the uncertainties, both global and domestic.
There are some signs of a modest pick-up in activity in the major industrial countries, and continuing assurance of monetary policy support. Portfolio flows to the emerging market economies (EMEs) have risen sharply.
The Reserve Bank of India rightly recognises that EMEs are vulnerable as, sooner or later, there would be an outflow of capital from them.
Domestic industrial growth and exports, and some mitigation of fears of an adverse monsoon have given tentative signals for revival of the economy. The RBI’s central estimate of growth in 2014-15 appears to be reasonable.
The RBI does well to reiterate its glide path for the Consumer Price Index (CPI) at 8 per cent for January 2015 and 6 per cent for January 2016. Although the January 2015 objective appears reasonably secure, the attainment of the inflation objective for January 2016 is still not too clear.
While there were some noises of protest when Rajan increased emphasis on the CPI, the de-emphasizing of the Wholesale Price Index (WPI) for assessing retail inflation appears to have been skilfully negotiated by the RBI.
Over time, it would be more effective if, for policy purposes, the RBI were to move over to a medium-term inflation objective.
This could take alternative forms: (i) point-to-point quarterly monitoring over a 36-month moving average and (ii) a moving average over the medium-term with weights in accordance to a distributed lag — the latest data being given the highest weightage and the most distant data the lowest weightage.
This would obviate very short-term blips in the inflation rate objective and consequently policy interest rates could be more stable.
It is desirable to emphasise a medium-term inflation objective as a decline in the monthly point-to-point inflation rate creates intense political economy pressures to reduce interest rates.
Equally, there are strong pressures for interest rate policy not to be trigger happy when there are upward blips in the inflation rate. To avoid both kinds of problems, the RBI would do well to develop early on a medium-term indicator for inflation which should then be well publicised.
Interest rates and SLRWhile the policy overnight repo interest rate has been appropriately maintained at 8 per cent, a legitimate concern being expressed in some circles is that multiple-term repo rates attenuate the effectiveness of monetary policy. Perhaps, at the next policy review on September 30, the RBI would do well to gradually reduce the number of term-repo durations ultimately to one term-repo duration, perhaps 14 days.
Further, there should be a gradual reduction in the present overnight repo. Not that there should be no overnight repo, but such access should be eventually at the marginal standing facility interest rate.
The progressive reduction in statutory liquidity ratio (SLR) is ostensibly to move towards market-related interest rates in the bond market and to also provide for space to the commercial sector.
But equally, SLR reduction is not consistent with a ₹600,000 crore gross borrowing programme. The whole issue of the proper development of the Government securities market needs a dedicated discussion.
While the reduction of the held-to-maturity (HTM) category to 24 per cent is appropriate, it would appear that the RBI lost its objective some years ago. As far back as 1996, the RBI raised the mark-to-market proportion to 60 per cent and it was then announced that the intention was to eventually go to a 100 per cent mark-to-market system. But then there was a complete volte face by the RBI and the HTM category was enhanced.
Had the 100 per cent mark-to-market formula been imposed there would have been faster development of the Government securities market with depth, liquidity and investors with different perceptions. Resorting to HTM was clearly a costly aberration as it was excessively concerned about the profitability of banks. Being concerned about bank profitability is in order, but it should not be at the cost of developing a genuine active secondary Government securities market. The RBI should swiftly phase out the HTM category.
Payments banks and othersThe issue of a payments bank needs discussion. Suffice it to say that it is a travesty of justice to expect the postal bank to apply for a payments bank licence. The postal bank is in a unique position to deliver on financial inclusion and denying it a full banking licence is unfortunate. It is well-known that the Ministry of Finance has been, for decades, against the postal bank becoming a full-fledged bank as it would deprive the Government of easy funds. Without a postal bank there will not be effective financial inclusion.
Small banks are vulnerable because of their limited geographical spread; a single natural disaster can wipe out the bank. Again, historically, the Indian experience with small banks has not been encouraging.
In the early 1960s, the RBI had to impose a regime of moratorium, amalgamation and mergers on hundreds of small banks. With the deeply ingrained belief in the immortality of scheduled commercial banks, the concept of a bank dying is alien to the culture of Indian commercial banking. The upshot of this is that profits are private and losses are public. The RBI should undertake a hard look again before going in for a proliferation of small banks.
The writer is a Mumbai-based economist