A lot has been discussed in the media regarding the policy transmission since the announcement of the monetary policy by RBI on April 7, including this paper (“Deciphering RBI”, FE, April 10, goo.gl/zSvFli). I would not like to go into the details, as the purpose of this piece is to highlight the veiled danger of imposing common regulatory standards post 2008 financial crisis. Even then, I cannot resist the temptation of providing a counter-factual to what was been said in that article.
The crux of the argument in this piece as well as in several quarters is that in a situation of liquidity abundance, a cut in CRR is foolhardy. While it is true that RBI has indeed de-emphasised CRR as its principal instrument of monetary control abiding by its stated objective of lowering reserve requirements to its statutory minimum level over the medium term, a reduction in CRR during a liquidity surplus regime can only immediately result in lower cost of funds for banks which gets reflected in lower lending rates. Also, past experience shows that a CRR reduction reduces volatility of both the weighted average call rate and the bid-ask spread. In the most recent period, between January 2012 to February 2013, when CRR was reduced from 6% to 4%, volatility in weighted average call rates and bid-ask spread (MIBID-MIBOR) reduced significantly.
Thus, a CRR change and liquidity management are agnostic. Additionally, the monetary policy operative framework has been tightened since the Deepak Mohanty committee report that replaced the corridor approach to setting the overnight interest rates (call rate) to a point target (viz. Repo rate). Together with this, the liquidity situation too was kept in deficit mode, quite as matter of conscious policy choice. These two elements together imparted an element of downward rigidity to transmission as if the liquidity is kept in deficit mode it would be difficult for banks to inject an element of downward bias to short-term rates. The lack of flexibility to set the short-term rates to reflect their liquidity position permeates into longer-term rates too. Thus, unless a bigger policy rate cut is effected, the bank’s ability to engineer rate cuts at the longer end is diminished. This situation is distinctly different from developed countries, where the financial system operates primarily in a liquidity shortage mode and one has to take frequent recourse to central bank liquidity. Indian banks, on the other hand, are deposit-driven and do not resort to borrowings on a larger scale. Interestingly, even if there is an adjustment in daily CRR (say, banks are not required to maintain 95% of CRR on daily basis), that may suffice.
Now, the central theme of this piece of creating a common regulatory architecture since the 2008 financial crisis. It is an important topic for deliberation today, as even though global policy coordination across regulators were swift, post-2008 crisis in terms of monetary easing, the evidence of post-crisis economic policy coordination remains weak. Herein lies the paradox, macroeconomic policies or for that matter common regulatory standards (for example, mandated liquidity coverage ratio—LCR) may lack the flexibility to accommodate the domestic macroeconomic shocks at home (an example in the case is the Bretton Woods system of fixed exchange rates that was abandoned in 1974). As Dani Rodrik argues: “The world economy will be far more stable and prosperous with a thin veneer of international cooperation superimposed on strong national regulations than with attempts to construct a bold global regulatory and supervisory framework. The risk we run is that pursuing an ambitious goal will detract us from something that is more desirable and more easily attained … Global financial regulation is neither feasible, nor prudent, nor desirable.”
In the Indian context, the numbers make an interesting reading. If we make a comparison of India across BRICS and Asian economies in terms of pre-emptive ratios like CRR and SLR, India has the largest (25.5%). If we add to this the priority sector lending commitments also, India has the highest stipulated norms across all such countries. Now, if we add to this the stipulated LCR ratios as mandated by Basel III, it legitimately raises the pertinent question of whether uniform global financial regulation is desirable and appropriate. As a matter of fact, asymmetric policy responses across developed economies have now become more fashionable and shows that every country may have to adopt differentiated macro policies to suit its own interest rather than go for a blanket uniformity in policies.
To sum up, we thus believe that global growth is more a function of domestic economic policies rather than international coordination of national efforts. With developing countries like India already committed to economic growth, international policy coordination is unlikely to yield improved domestic policies or outcomes, no matter how hard we may try.
The author is chief economic advisor, State Bank of India.
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