There is no abatement of wage inflationary pressures. Although the inflation levels are slightly more alarming than at the time of releasing Credit Policy for 2007-08, the treatment could be different because of two reasons: global contagion effect on prices; lags in domestic production; continuing uncertainties in the stock markets, unlikely dramatic increases in market forces and more importantly, the political pressure to do something dramatic. Let me see the possibilities.
The Annual Report of the RBI 2001-02 (page51) mentions, Monetary policy regimes undertaking disinflation strategies involving a permanent movement from a high/medium inflation regime to low inflation may, in the interim period, have to suffer potential output losses. The threshold inflation rate of 5% crossed dramatically after February 2008 is proving to be not an event but a process. The RBIs real GDP growth expectation of 8.5% for the year 2007-08 exceeded just by 0.2%. The aggregate money supply, M3 that was 20.8% in 2006-07, increased by almost the same percentage in 2007-08. As against the expectation of Rs.490,000 crores rise in M3 by March 14, 2008 it touched Rs.6,72,020crores. This, in effect means that the RBI could not restrict the money supply at its targeted 17-17.5% . There was not much increase in the reserve money. Bank credit to commercial sector, this fiscal is down by nearly 5% on year-on-year basis. The origin of money growth is not internal to the economy. The foreign currency inflows continue to significantly influence the increase in money supply as they grew by 38.9% this fiscal compared to 27.7% last fiscal. Therefore, sterilisation of the inflows without affecting the growth is bound to receive adequate attention. Against an inflationary expectation of 5% under, the aggregate money supply should not be allowed to bypass the target of 17% with effective quarterly monitoring.
Interest rates on government securities have been maintained at a level much lower than that on the other financial assets (with a comparable maturity period) in the organised sector.
The Statutory Liquidity Ratio (SLR) plays a dual role: it can affect the aggregate supply of money as also the distribution of bank credit between the public and private sectors. A change in SLR could cause a transfer of government securities from commercial banks to RBI or vice versa and would lead to an increase or decrease in the supply of high power money. Basel II is on. Banks have to go for Tier II capital instead of Tier I in the context of uncertainties in the capital markets. Bond markets have to be kept active and derivatives have to be carefully handled in the wake of the subprime crisis. In view of the strong recommendation of the Committee on Financial Sector Reforms headed by M Narasimham that the SLR investments should be progressively market related and that it should be kept at 25%, this instrument may not be touched.
International crude prices have been on the rise and touched $109. Because of global pressures, in all probability we should expect that there would be no further escalation in oil prices. In the context of a macroeconomic imbalance giving rise to continuing inflation more due to supply shock in the backdrop of continuously falling production for the entire previous fiscal in all the sectors and more particularly, agriculture, and the rising global prices of food grains, more import of which could give rise to importing inflation further, measures like price controls or excise-cum-customs duty cuts for reducing pressure on prices, may prove inefficient. Sectoral intervention for purposes of tackling inflation in the areas of food and other essential items, falls under the regime of the State and Central Governments. RBI cannot be expected to do micro management of the economy. Under these circumstances, containing food credit would be problematic. Containing non-food commercial credit could retard the growth target of the Eleventh Plan. Growth in farm credit is psychologically hit with the Rs 60,000crore write-off of agricultural credit. SMEs have shown good performance and deserve further push as they are highly supportive to the entire manufacturing sector. There is a need to incentivise higher credit flow to the SME sector through a specific policy measure.
If it does not want to signal significant interest rate manipulation, the repo and reverse repo rates could be increased by another 50 basis points immediately. This would still leave the bank rate unchanged. PLRs could be subject to revision by the respective banks depending on their perceptions of the market and responses to pressures. 75% of the banking system is still under the control of the Government and the latter can still influence the Banks to lend to unproductive but politically expedient sectors where asset performance is highly doubtful. Annual Credit Policy may do little to influence this factor.
The lofty ideals of financial inclusion may be dinned into the ears of the Banks once again as the performance under this score leaves much to be desired. It is not easy to administer a quick medicine to the diabetic patient. What monoclonal antibodies that Reddy would administer in his last Annual Policy is worth watching.