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Thursday, Sep 16, 2004

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Opinion - Editorials

TACKLING INFLATION

THE HIKE IN the Cash Reserve Ratio (CRR) and the lowering of the interest payable on the reserve represent the Reserve Bank of India's first anti-inflationary initiative on the monetary policy front. With inflation running in excess of 8 per cent, the RBI had probably no option but to step in. Earlier the Government had tried to moderate price increases in key commodities in various ways: introducing a price band for the transportation fuels, petrol and diesel, and following it up with a more direct step of reducing indirect taxes. These were meant to give a measure of protection to consumers against the volatility in oil prices in the international markets. A week later, a package for steel and steel products was announced. Apart from lowering duties on imports, the Government simultaneously persuaded domestic steel producers to reduce their prices.

The RBI action comes in the wake of a realisation that supply side correctives will have to be supplemented by monetary measures to curb inflation. By hiking the CRR from 4.5 per cent to 5 per cent in two stages, the RBI aims to impound Rs.8,000 crores, one-fifth of the estimated Rs.40,000 crores of surplus funds that banks have placed with the RBI. In a traditional sense the CRR hike should, by reducing credit availability, make corporate borrowing costlier and thereby apply the brakes on a runaway expansion in investment demand. This time round that sequence may not take place because of abundant liquidity; banks have enough funds to expand credit significantly. The second part of the package, a reduction in the interest that the RBI pays on CRR balances of banks from 6 per cent to 3.5 per cent, is expected to help in containing inflation, but in a more subtle way. According to a rough estimate, banks stand to lose Rs.1,788 crores by way of reduced interest earned. Given that gilts trading (that brought in the bulk of the profits for commercial banks last year) may not come to their rescue this year, banks will have to lend more and in a much more aggressive fashion if they are to maintain their profitability. The RBI has not altered the repo rate, the rate at which banks lend to the central bank. Credit-shy bankers were finding it safer to place surplus money in government securities and with the RBI. Not only do banks stand to lose a considerable portion of their interest income on their CRR balances, they will also have to reckon with a vastly depreciated securities portfolio in the wake of rising bond prices.

The central bank which is committed to reducing statutory pre-emptions to the barest minimum had probably no choice but to go against the trend and put up the CRR. A bank rate hike will be politically unacceptable and, worse, will make government borrowing costlier. It is evident that having run out of securities, the RBI cannot rely, as frequently as it did in the recent past, on open market operations to mop up the excess liquidity in the system. The CRR package of Saturday attempts to address rising inflation without immediately signalling an interest rate increase, or compromising the credit needs of the real sector. It is fortuitous that the stock markets continue to receive large funds from abroad despite the high inflation and rising commodity prices. As a consequence, the rupee has been appreciating after breaching the Rs.46-to-the-dollar barrier. Cheaper imports will not only reduce the import bill but also serve to push down prices in the domestic market.

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