Tuesday, February 05, 2013

Reserve or reverse, it’s his choice; really!

low growth or inflation; it was a tough choice to be made by the RBI Governor. The problem is, despite a quarterly review of the Monetary Policy, he’s still to make the choice, says Manish K. Pandey
 
It was quite a spectacle on the morning of January 29, 2010, at the RBI headquarters in Mumbai, when a seemingly nervous Duvvuri Subbarao, Governor, Reserve Bank of India (RBI), read out the third quarter review of Monetary Policy 2009-10 in a rather ‘ill-at-ease’ fashion. And why wouldn’t he be? After all, he had a daunting task at hand – to tame price instability without jeopardizing the country’s economic growth. So how did he go about playing with the numbers? While he hiked the cash reserve ratio (CRR) of banks to 5.75% from 5% (this was higher than market expectations of a 50 bps hike on the CRR), he left the repo, reverse repo and bank rates unchanged at 4.75%, 3.25% and 6% respectively. So were these changes enough to guarantee an accomplishment of some sorts?

If one looks at the overnight money market rates, they have remained close to the lower band (3.25%) of the liquidity adjustment facility (LAF) for months now, thereby reflecting the huge liquidity bulge. In fact, the banking system has been depositing over Rs.1 trillion on a daily basis under the LAF window during the current fiscal. Considering this, the two-phased hike in CRR (a 50 bps increase on February 13 & the remaining 25 bps increase on February 27), which is expected to squeeze out Rs.360 billion of liquidity from the system, is certainly not going to make much of a difference to the ongoing supply-demand imbalance. Further on, an immediate hike in interest rates is also an unlikely phenomenon (most bankers have already pointed this out). So the moot question is whether Subbarao has given the right twist to the numbers or not.

Explaining his choice of adjusting the CRR than the interest rates, Subbarao says, “If we had used interest rates, it would mean that the amount of liquidity we would have absorbed would have been more unpredictable.” True, but, was there really a need to tamper with any of them? More dangerously, by increasing CRR, hasn’t RBI made both inflation and growth more unpredictable? In fact, RBI has raised both its growth and inflation forecasts. While on one hand, it raised its end-March WPI inflation target to 8.5% from 6.5% earlier, the GDP growth forecast for FY2010 has been raised to 7.5% from 6%!


Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

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