Column : A well tuned policy orchestra

Written by Subhomoy Bhattacharjee | Updated: Oct 24 2008, 06:43am hrs
Governments can do only certain thingsthey can work in abnormal situations spectacularly. They just do not deliver when the need is sustained good business practices. Along with the rest of the world, the Indian government worked wonders in the last three weeks. It has pulled the credit market out of deep freeze, pushed panic out of the Indian stock marketwhen was the last time a Prime Minister said be prepared for a temporary slowdown and saw the markets move up 460 points, and got the rest of the economy too to believe that India can weather the financial storm.

But that is no example to believe that it should continue to run the business of business. It ends up doing things spectacularly wrong in normal situations, and I will return to that in a moment.

On Tuesday, the Indian banks parked Rs 27,695 crore with the Reserve Bank of India at 6% rate of interest. This is the clearest demonstration of how India has been able to handle its liquidity crisis. The banks now have surplus liquidity, thanks to the concerted set of actions taken by the Reserve Bank and the finance ministry to tank up the credit markets with liquidity. The fab figures are not just emerging from the government repo market. Volumes have picked up in the market repo too. As on Tuesday, RBI data shows the volume in the market repo was Rs 11,107 crore at a weighted average rate of interest of 6.55%. Volumes are of course still thin at the longer end of the market, with the term money attracting a transaction of only Rs 55 crore. It is however too soon to expect the changes to reflect here immediately.

At the other end, this newspaper has carried a story this week, of how Metro, the wholesale cash and carry company from Germany, has been told by the West Bengal government that its license will only be renewed if it just sells to traders. The interesting aspect is that it is the government which has taken upon itself the role of deciding who is a trader. They have to be certified so by the respective municipal administrations.

Whether Metro should do business here or pack up is not important. The company can do business based on its assessment of the market risk, but the terms of the licence just demonstrate what happens when a government decides to meddle in business over the long term. Each of the provisions, irrespective of how they impact on Metro is an open invitation for government induced arbitrage for traders in the state. Incidentally there are reports that some of them were foisted by a domestic industrial group, which proves even more how the lessons of the incentive and the opportunity to act arbitrarily by the government are internalised by business, too.

This is the danger that surfaces when governments work as the saviorthe deux ex machina. When the financial whiz kids of Lehman Bothers goofed up in grading securities they were blown away in the ensuing maelstrom. When government mandarins do the same, tax payers pay the clear up charges for generations.

For instance, if government ownership were a virtue, the clutch of 29 public sector Indian banks should have been world leaders by now. Instead the only significant Asian economy that will not add a foreign label to its financial street would be India. As the world money markets froze on September 16, Indian companies too were caught in the drying up of credit. But the Indian public sector banks were simply in no shape despite the government guarantee on their balance sheets to do anything about it. So much for the safety and the security of government ownership of business! The thing that governments do best is step in when a crisis occurs and no other agency does that better.

Reverting to the present financial crisis, the way finance ministry, the Reserve Bank of India and the Securities and Exchange Board of India have moved together has been really commendable. It was almost metronomic the way the steps of one agency followed the other before the day was over. This level of coordination was never visible in the Indian financial system and it has helped. Forex analysts said the fall out has begun to clear the

Indian market of regulatory arbitragethat has been so typical here. Wednesdays fall in the value of the rupee is a clear evidence of this trend. The rupee is falling but there are no one way bets in the currency futures market on the national stock exchange, on which way the currency would move.

To understand how different the present environment is just remember the kerfuffle on the participatory notes in October 2007. Those who stuck by the Sebi and the finance ministry impressions that there was nothing wrong in the practice, lost out as PNs in derivative instruments were banned. Those who bet the RBI point of view would prevail were the winners, as they had unwound their positions. But to use this episode to develop an argument for government control is to invite disaster.