The central bank's current monetary policy, having evolved from focusing solely on controlling inflation and emphasising independence, is aimed at supporting economic growth
By Pradip Shah
In an interview reported on July 22, 2019, Governor Shaktikanta Das was quoted as saying that the Reserve Bank of India (RBI) was doing everything at its disposal to be in sync with the government’s efforts to accelerate economic expansion, be it interest rate cuts, ensuring sufficient liquidity or enabling more bank lending.
From the time of Das’s appointment as Governor, RBI in December 2018, there has been a noticeable change in RBI philosophy. Under the leadership of the two immediately previous governors, RBI had an unwavering focus only on controlling inflation and, emphasising its independence; it ignored other government objectives, such as increasing economic growth or employment.
The objective of the Bank of England’s monetary policy is to deliver price stability and, subject to that, to support the government’s economic objectives, including those for growth and employment. The US Congress established the objectives for monetary policy by statute, the Federal Reserve Act, not leaving it to the independent thinking of the Fed—maximum employment, stable prices, and moderate long-term interest rates. The Law of the People’s Bank of China explicitly stipulates that the ultimate goal of China’s monetary policy is to maintain currency stability, and thereby facilitate economic growth—clearly, economic growth is the ultimate objective. The evolution of RBI’s monetary policy objective from solely controlling inflation to supporting the government’s objective of economic expansion is a refreshing and much-needed change.
RBI has sought to lower interest rates, but seems frustrated that there is a long lag between the time it lowers its repo rate—the rate at which banks can borrow from RBI in case of shortage of funds—and when the banks lower their lending rates. To speed up transmission, RBI should dramatically decrease the reverse repo rate—the rate earned by banks on deposits with RBI—so as to discourage banks from lazy banking. Public Sector Banks (PSBs) are blessed with huge inflows into savings and current accounts, notwithstanding their financial performance because of the customer perception of safety and trust that the Government of India is behind these PSBs; they get a decent return (5.15% even after the reduction on August 7) on such inflows without taking any risk by merely depositing them with RBI. Indeed, the reverse repo amounts totalled over Rs 2 lakh crore at the end of the first week of August, up from `1 lakh crore in mid-July. This has occurred at a time when MSMEs, NBFCs, and potential borrowers are complaining of lack of availability of finance.
Since RBI has expressed its intention to enable more bank lending, reducing the reverse repo rate to a level where it is no longer attractive for banks to put deposits with RBI is a desirable and necessary step. One-third of sovereign bonds globally carry a negative rate of return, i.e., investors will get back less than what they paid at the time of issue, paying a price for safekeeping of their funds. Banks must likewise pay a price if they want the safety of deploying funds with RBI; otherwise, the banks must play their role as intermediaries between savers and borrowers, and seek out borrowers. The private sector banks have shown that there is no dearth of such customers at this time. If the reduction in repo rates leads to a reduction in deposit rates, it is only fair given the low-inflation scenario prevailing currently; the government must then act with alacrity to reduce administered interest rates, such as the unconscionable tax-free rate of return on provident funds and small deposit schemes.
The US Fed, Bank of England, Bank of Japan have been forward-looking in employing the tools of monetary policy at their disposal. In developing its monetary policy, Bank of Japan employs the Tankan survey, a quarterly poll of thousands of companies that have linkages with economic conditions. The companies are asked about current trends and conditions in the business place and their respective industries as well as their expected business activities for the next quarter and year. For example, firms are asked about domestic demand and supply, inventory levels, projections for inflation, and the number of new graduates they hired in the last year. A rear-view mirror of “hard data”, which comes with a lag, results in dated inputs for monetary policy decisions. RBI must develop an efficient system of assessing every quarter forward-looking economic sentiments of rural and urban consumers and businesses as inputs for its monetary initiatives.
In the developed world, monetary policy is proactive and fiscal policy lags in response to developing economic situations. In India, monetary policy has hitherto been reactive while fiscal initiatives are more proactive—for instance, RBI, in its Monthly Monetary Policy Statement 2015-16, dated August 4, 2015, acknowledged the “Government’s current pro-active supply management to contain shocks to food prices, especially of vegetables, alongside its decision to keep increases in minimum support prices moderate”; the central government is trying to pace out capital expenditure evenly over the fiscal year instead of having it bunched towards the end, as was the practice in earlier times. Where the central government has miserably failed is in its own objective of ease of doing business, and in gross inefficiency in administration—witness the initiatives of the Ministry of Corporate Affairs, such as striking off companies which only hurts lakhs of innocent employees, directors and creditors while protecting the crooked cronies from tax claims, the poor implementation of the GST and the IBC, the tax initiatives introduced without homework, such as the tax on FPIs. If the central government wishes to slow down the slide in the economy and improve the growth rate, it must recognise that the enemy is within—and it is the bureaucracy.
RBI can also play its part in ease of doing business—for instance, avoiding classifying bank accounts as “dormant or inactive”, which entails hassles for small depositors, avoiding paperwork for foreign receipts and payments, which even exporters have to comply with, removing the requirement of filling a KYC repeatedly for a bank customer transferring amounts to mutual funds or opening broker accounts or demat accounts, encouraging speedier adoption of technology to serve customers better.
Too much was being made of the “independence” of RBI in the recent past. No one ever advocated reducing RBI’s role in controlling money supply. Monetary policy objectives must be dovetailed with fiscal policy objectives, and Governor Shaktikanta Das’ endorsement of this is a refreshing recent change at RBI. Along with economic growth, RBI may explicitly aim to facilitate employment, and less-explicitly, to prevent currency volatility; work with SEBI and others to facilitate foreign inflows to augment foreign exchange reserves, and to reduce the onerous form-filling requirements, thereby facilitating the less-privileged to put financial savings into financial instruments rather than land or gold; develop a framework in association with SEBI and the government for managing the possible systemic risk from large finance companies and from debt mutual funds, which do not enjoy lender-of-the-last-resort support or an inter-institutional market like the inter-bank market.
Author was founding Managing Director, CRISIL