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Why policy statements must be inclusive

The aim should be to carry the message to a wider public

— Photo: Paul Noronha

REINING IN BANK LENDING: Y. V. Reddy (centre), Governor, Reserve Bank of India, with Deputy Governors (from left) Usha Thorat, V. Leeladhar, Rakesh Mohan and Shyamala Gopinath prior to the announcement of the credit policy in Mumbai on April 18.

ACCENT ON continuity has become the hallmark of the Reserve Bank's monetary policy. Perhaps the very nature of its composition — plenty of emphasis on macro economic factors in play, the external situation and of course the financial sector — makes sudden and unexpected policy changes impossible. Continuity is in fact a virtue when one considers that infrequent or gradual changes in the policy framework indicate an underlying economic stability.

Gradualism may, however, be mistaken for caution but it cannot be denied that beyond interest rate changes there is hardly anything with which the RBI can surprise the market or laymen through its monetary policy pronouncements.

No room for surprises

There is another reason why major policy statements such as the monetary and credit policy have adhered to a predictable format in recent times. It is the intention of policy makers to demystify the subject. The RBI has been in the forefront of such moves in one significant way. Realising that sensational policy pronouncements are often less intelligible, the RBI has been deliberately downplaying them.

In fact the idea has been to make the occasion of a monetary policy statement a "non-event", devoid of headline catching news. Interest rate changes and related announcements can be made independently and need not be tied to the monetary policy dates. That will also confer the benefit of flexibility to the policy.

Since last year, the RBI has been having greater interaction with the market and the public. Together with two new quarterly reviews and the mid-year review, the monetary policy can now be scrutinised every quarter.

Less sensational budgets

Changes have been taking place elsewhere too. Even the normally sensational budget announcements appear routine in many developed countries. In India too the trend is clear. Tax policies have become fairly predictable. That again is due to the fact that major policy issues — tax reform, VAT procedures and so on — are discussed in great detail practically throughout the year. The public finance agenda is partly set by the fiscal responsibility legislation that binds the government to a deficit reducing agenda over the medium term.

Monetary policy is primarily directed at bankers and other financial intermediaries. For it to have a wider appeal, at least two conditions must be met. The narration should be as simple as is possible and a balance should be struck between unavoidable jargon and the requirements of the lay reader.

For the common man

More importantly, the policy statement should reach out to a wider audience than those for whom it is immediately intended. The goal should be to involve a larger number, including those who may not have a direct "stake" in the issues dealt with.

Compared to, say, the budget (especially the Finance Minister's televised speech), the monetary policy offers few items that affect lay people directly and immediately. The only exception, of course, pertains to interest rates. The Annual Policy for 2006-07 has steered clear of altering interest rate signals. Neither the short-term repo rates nor the bank rate have been touched. Even a widely anticipated reduction in the CRR — a liquidity enhancing measure - has not taken place. That would have increased the availability of funds and thereby dampened the hardening sentiment on interest rates.

What are the messages for the man on the street? The RBI might not have signalled an upward movement of interest rates but has made many types of bank loans more expensive. Henceforth, personal loans, capital market exposures and high value home loans and loans against commercial property will be dearer because the RBI wants banks to make a larger provision for such exposures and increase the risk weight in specific cases.

Reckless retail loans

Pertinently some of these loans were perhaps made too freely available in the recent past. The RBI had more than once cautioned banks against inadequate documentation while disbursing home loans. More generally there have been fears that even public sector banks, forced to emulate the new private banks and the foreign banks, were plunging headlong into retail loans. Such recklessness will come at a price, perhaps not immediately, but definitely when there is a shakeout and defaults start.

So it is just as well that the RBI has adopted selectivity: cautionary words of the past have now been backed by tighter accounting norms to check proliferation of certain categories of bank loans. A more general signal to hike rates would have been politically difficult and might have impacted negatively on the robust business confidence. But the debate on whether interest rates will or should go up in the near future is far from settled.

The biggest worry is inflation. Global oil prices, currently around $70 a barrel, are not expected to come down soon. According to reports, India's oil basket — which will approximate the near term oil import bill — now costs around $65 a barrel. Domestic consumers have so far been insulated to an extent, through a combination of subsidies, fiscal measures and passing on part of the burden to the oil companies. At some point it will not be possible to shield domestic consumers to the same extent. So what is called the "pass through" effect is very much in the reckoning.

That has been the principal cause for inflation expectations. Even the RBI expects inflation to be higher this year — between 5 and 5.5 per cent (as against the below 4 per cent level now). Further justification for an interest rate hike exists. Globally most central banks have hiked the rates .The RBI too has in the recent past been signalling a higher rate — the repo rates have been raised successively.

Asset bubble in the making

Moreover, in the context of soaring asset prices, an interest rate hike would have been a worthwhile option. The Sensex crossed 12,000 during the week the credit policy was announced. While the share price rise is attributed to the twin factors of continued investment by FIIs and domestic mutual funds, there is far less unanimity on what drives the prices of practically all types of assets — gold, silver and many other metals.

The credit policy seeks to rein in bank lending to the property and share markets. The central bank's concerns of as an asset bubble emerging are valid. But there is far less agreement on whether the measures announced are enough to check the asset price inflation or even whether there is an incipient bubble.

C. R. L. Narasimhan

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