The last formal statement by the Reserve Bank of India on the state of the Indian economy, the mid-term review of October 2001, was an admission of a difficult economic situation. The growth projections had been lowered. Since then, the external economic environment seems to look more promising. Domestically, agricultural performance seems set for a distinct improvement. The rate of inflation, even earlier no cause for alarm, continues to be under control. So with things going fine, RBI has no reason to feel under pressure to lower the interest rates.
Recent signs of recovery in the United States, though feeble at the moment as labour demand is yet to pick up, suggest that world demand may be on an upward trend. The Federal Reserve Chairman, Alan Greenspan has said as much and Kenneth Rogoff of the IMF is already talking of ...the recession that almost was. Compared to 2001 when world trade slowed down to almost zero from the 12 per cent growth in 2000, the external economic environment may expectedly be more favourable in the near future. So even though trade data available so far indicates that the spurt in export and import growth in December 2001 to January 2002 was not sustained in February, export growth can be expected to pick up as world demand improves. Trends that will become clear a little later in the day.
Incidentally this is not the only positive development on the external front. Other economic indicators here are positive too. Both portfolio and foreign direct investment flows have been buoyant and sustained in the fiscal year 2001-2002, indicating the confidence of the international investor. The foreign exchange reserves situation is more than comfortable and the exchange rate, along with its guardian, has more or less been behaving itself.
Things on the domestic front are not so good though. The revival of domestic demand continues to dog the policy maker. The quarterly estimates released by the Central Statistical Organisation or CSO show that the combined gross value added originating in mining and quarrying, manufacturing and electricity, gas and water supply was lower in the third quarter of 2001-02 over the same period previous year.
Subsequent developments showed a rise in the index of industrial production between November-January, but a dip in February suggests that the rising trend is yet to stabilise. The optimistic note is struck by the price situation, which is well under control. The increase in non-food credit growth over last year hints at a rise in resources flowing to the commercial sector. And agricultural production is expected to be good. The official advance estimates show that the combined foodgrain output, kharif and rabi, for the current year will exceed last years output by almost 15 million tonnes. This may revive rural demand, which hopefully may trigger the economic recovery process. Again this is something which remains to be seen.
So when the earlier downcast scenario saw the RBI revise the growth projections downward, it would be no surprise if the expected monetary and credit policy revised the GDP projections upwards for 2002-03. Earlier, citing sentiment as the reason, the RBI had lowered the interest rates in October 2001. This time round, with preliminary economic indicators suggesting an improvement in sentiment, only the naive would look for a substantive lowering of interest rates. The RBI may well adopt a wait and watch attitude. Or give a further push to the positive sentiment as also in support of the cut in administered interest rates announced in the union budget this year lower the interest rate by half a percentage point.
Just as the union budget exercise has become a forum for announcing a range of policy measures, it has also become a tradition with RBI to announce policy reform measures in the financial sector. For instance, the past few monetary policy announcements have steadily lowered the cash reserve ratio. These cuts have not really indicated its monetary policy stance, but have been geared towards achieving the RBIs long-term goal of reducing the CRR to its statutory minimum under the roadmap of financial sector reform.
Amongst important unfinished items of financial reform are those of strengthening supervision, governance and mechanisms for the resolution of non-performing loans, which are high by international standards.
The eruption of the Unit Trust of India affair and other rumblings in the financial sector last year pointed towards the need to improve governance in banks and financial institutions, as well as have prudential and supervisory systems in place to ensure financial stability.
While strengthening supervision has been making steady progress, response on governance issues has been quite slack. Recognising the need for further improvements in governance, the RBI initiated a fresh examination of the role of board of directors of banks and financial institutions by setting up a consultative group in the October announcement.
Its likely that issues of evolving and implementing professional governance standards within the entire financial sector may figure in the coming monetary policy announcement, as this is perhaps one of the most important, but unaccomplished items of financial reform. The monetary and credit policy statement this year may well be meaty on aspects of financial sector reforms rather than interest rates per se. The author is a professor at ICRIER and on deputation from RBI. The views expressed here are personal and not of the institution to which she belongs