The Reserve Bank has acquired the reputation of being tough under Governor Bimal Jalan. But the mid-term monetary policy measures, announced on October 29, show that Jalan can also be flexible. This is seen in the decision to bring down the cash reserve ratio (CRR) of banks by a full percentage point in two equal instalments next month. This will increase banks’ lendable resources by Rs 7,000 crore. The CRR on FCNR(B) deposits goes from November 6, putting an additional Rs 1,061 crore in banks’ lendable kitty. This may seem to be a concession to the popular demand for a cut in the CRR. According to the Reserve Bank, deposit growth is in line with its April projections; so too are the real sector trends. So, why the CRR reduction? But M3 growth slowed to 7.9 per cent (October 9) this year from 10.1 per cent in the corresponding period of last year. The CRR reduction was probably necessary to take monetary expansion this year to a ‘‘reasonable’’ 15.5-16 per cent.

The mid-term policy makes a distinction (so to say) between adequacy of banks’ lending resources (taken care of by the new CRR of nine per cent, which can be varied if circumstances warrant) and liquidity which, says the Reserve Bank, has been ‘‘generally’’ easy, but volatile in the short-term money market. To cope with the latter, adherence to CRR has been lagged by two weeks to enable banks to precisely calculate their reserve requirements; and the Reserve Bank will keep open the purchase window for treasury bills; besides, it will expand (or contract liquidity) through repos, collateralised lending and open market operations. (This may not be good news for money market mutual funds which thrive on volatility, but that is another story). And to take care of likely Y2K cash problems, there will be special liquidity support related to the entire excess investment over the statutory liquidity requirement.

Corporates will not be enthused by the latest credit policy, not merely because the ceiling on exposure (lending) to an individual borrower is to be lowered from 25 per cent to 20 per cent of a bank’s capital funds (this will create space for new borrowers as also for infrastructure lending) but for a more fundamental reason. Corporates have been pressing the Reserve Bank for a reduction in banks’ lending rates. Jalan has, in effect, proclaimed that they are barking up the wrong tree: ‘‘Prime lending rates of banks for commercial credit are entirely within the purview of the banks and are no longer set by the Reserve Bank’’. He points to the constraints of banks. Their high average interest cost of funds (eight per cent) plus their non-interest cost (2.5-3 per cent); plus the ‘‘high overhang’’ of non-performing assets which requires the banks to keep a fat mark-up. High lending rates are thus a structural problem. That is quite a damper on corporate expectations. Only a rise in inflation, with a consequent decline in real interest rates, seems to be the answer to corporate prayers!

Then comes classic Jalanspeak. Demands for interest rate reduction should be addressed to the government. He points to the interest tax (0.5 per cent) which pushes ‘‘further’’ the lending rates, the persistently large volume of government borrowings from the market, which gives an upward bias to the interest rate structure, and the government-determined interest rates on provident funds (12 per cent) and the National Savings Scheme (11 per cent), which are higher than the long-term deposit interest rates of banks.

True, if the CRR could be cut deep, the average cost of bank deposits would decline. But, says Jalan, the CRR is kept high in order to control the overall expansion of liquidity in the system. The short point is that monetary and credit policy can go only as far as it is allowed to by fiscal policy. Over to Yashwant Sinha.