Busy season business

Policy challenge for Jalan and Reddy

With the monsoon approaching its annual break and festival season nearing, the central bank gets busy with its mid-year review of the economy and the so-called “busy season” policy statement. In keeping with recent practice, it can be expected that Reserve Bank of India governor Bimal Jalan may not tie up all policy decisions with the monetary policy statement, but instead take them as and when necessary. A reduction in the cash reserve ratio, perhaps by 0.25 per cent or 0.50 per cent, is widely expected. This would inject liquidity of upto Rs 4,500 crore. With the US Federal Reserve once again announcing a rate cut, there is widespread speculation that the RBI may yield to pressure and go in for a bank rate cut. In the columns of this newspaper yesterday our valued columnist, the former RBI deputy governor S S Tarapore cautioned his successors against succumbing to such populist pressure. Interest rate reductions in India have clearly gone too far, says Mr Tarapore, and the scope for another rate cut is limited. Both governor Jalan and deputy governor Yaga Venugopal Reddy have suggested in recent weeks that while there may be a good case for reducing the burden of interest cost on domestic producers and businesses, this factor is not holding back economic activity nor is it restraining demand for credit. The constraint on growth is operating from the demand side and not the supply side.

Governor Jalan has gone a step further. He has drawn attention to the limits to interest rate cuts within the existing paradigm of deposit rates and banking sector efficiency. Interest rate reduction, he seems to be suggesting, has finally hit the boundary set by existing deposit rates and the efficiency of the financial sector. Pushing the rate further down will hurt both depositors and banks. Are we ready for it? Mr Tarapore thinks not, Dr Jalan and Dr Reddy seem to by and large agree with this view, even though they may still have an open mind on the subject and are listening to what specialists and politicians have to say on the matter. We concur with Mr Tarapore’s view. We are living in extremely unstable times. The stimulus for growth must come from the demand side and by an alteration in the state of expectations. India is not the US. The Fed can teach us little since there will be no White House or US Congress to bail us out of a crisis. Prudence and caution are well advised till the world returns to more even keel.