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Message from CRR hikez financial scene

Last Thursday the Reserve Bank of India hiked the cash reserve ratio for banks by 0.50 percentage point. The increase, to be implemented in two stages, will take the CRR to 8 per cent.

The CRR is a statutory ratio of great relevance to modern monetary management. It is calculated as a percentage of deposits that commercial banks are required to keep with the RBI. The idea is to impound money and check excess liquidity which is a contributory factor for high inflation.

The other important ratio is the statutory liquidity ratio or SLR which now stands at 25 per cent. Banks are required to invest in certain approved securities up to the stipulated percentage. Unlike the CRR, the SLR has remained unchanged over a fairly long time. Nevertheless, for an entirely different reason, it has been in the news.

Public sector banks have often been investing far more than is necessary in the ‘safe’ SLR instruments. Consequently, at those times they have been lending less. Either they did not have viable business propositions or more likely they were exhibiting all the characteristics of risk aversion.

Ahead of the annual credit policy announcement — it is to be unveiled on April 29 — the RBI has chosen to impound liquidity and send an important signal to banks and the financial markets. Monetary tightening was, in fact, widely expected this season. Inflation had climbed to a 40-month high of 7.41 per cent on a year-on-year basis by the end of March. Although for the subsequent week it moderated slightly, the WPI inflation is still above 7 per cent and likely to remain high for the next few months.

The price rise has inevitably become a major political issue ahead of important State level elections. Naturally it dominates all macroeconomic discussions as well. The Government has been on overdrive announcing some fiscal and administrative measures to increase the domestic supply of commodities and products whose short supply has pushed up prices.

Unfortunately, the world over, there has been a sharp escalation in the prices of all agricultural commodities including rice, wheat and corn. It is this globally induced food inflation that has been one of the principal causes of the current high price levels in India. Other products — many varieties of steel, cement and a few other manufactured goods — have also contributed to inflation. Apart from trying to increase their supply, the government has tried to discourage exports. The Finance Minister has been talking tough and promising action against cartels and other forms of price-fixing in scarcity driven markets. The role of monetary policy in supplementing the supply side anti-inflation efforts will come into focus. More so because, the annual policy statement already scheduled is round the corner. It is, however, not at all surprising that the central bank has chosen to act on many occasions before the policy date. The number of times it has effected CRR changes outside policy dates far exceeds the times in which these were part of policy announcements.

Monetary tightening has always been on the cards. Inflation has been running well ahead of the RBI’s own comfort level of 5 per cent. The argument that monetary policy can do little to influence the supply side factor does not in any way lessen the central bank’s role in fighting inflation. For quite some time now, the RBI, in its monetary policy statements, has shifted the emphasis to maintenance of price stability in preference to economic growth. At the present juncture, when alarm bells are ringing all around, the RBI could not possibly remain a mute spectator.

The central bank has to anchor inflation expectations and check the second round impact of higher input prices. In fact inflation may not be entirely driven by supply factors.

There is also evidence of excess demand. Trained manpower is in short supply. Wages in several sectors are going through the roof. The shortages in steel, cement and other products are again a consequence of excess demand. Besides, the fiscal policy is influenced by populist considerations. Huge wage hikes for civil servants are on the cards. Also, high oil prices and the global food crisis will ensure that inflationary expectations will remain high.

By hiking the CRR, the RBI has opted for liquidity containment but it is by no means clear whether it will stop with that. There are some valid points against a repo rate hike. The economy is slowing down and external demand is weak. There is every likelihood of capital inflows moderating, an ominous trend considering that the current account deficit is widening. It is capital inflows, mainly into the stock market, that has helped in bridging the deficit and contributing to a surplus in the balance of payments.

On April 29, the RBI’s next round of anti-inflation policies will be announced. Whether they will involve a policy rate hike or stop with some hawkish words will depend upon the central bank’s reading of the economic trends.

C. R. L. NARASIMHAN

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