This is the crux of the matter. When Bimal Jalan was appointed in December, he was given an absurd task by finance minister P Chidambaram that he was not to let the rupee depreciate, and he was to stop the erosion of the reserves. Indeed, Mr Chidambaram seems to have indicated elsewhere that he did not favour Montek Singh Ahluwalia as RBI Governor because Mr Ahluwalia was in favour of a cheap rupee. Given this circumstance, the only choice left to Dr Jalan was to disinflate the economy, which he proceeded to do by raising the bank rate and the cash reserve ratio. His deflationary policy has prolonged the slowdown, which shows no sign of an end.
Getting recovery going
Mr Chidambaram had made enough waves in his short tenure as finance minister and was intent on ending his term without making any more. But Yashwant Sinhas objective function is quite different. He can reasonably expect to make two budgets at least. What happens to him and his party beyond that will crucially depend on whether he can get an industrial recovery going. The speculative risks faced by the rupee on account of the East Asian crisis were still real in December; they are no longer so today. The risk that an overvalued rupee will slowly undermine the balance of payments is still there. But a trade-based crisis will give plenty of notice, and the government will have plenty of time to react. Hence the finance minister should adopt a prominently, resolutely expansionary stance. Doing so in the budget would be problematic for the effect it would have on the fiscal deficit; but an expansionary monetary policy would have been no skin off the finance ministers nose. For instance, the cash reserve ratio could have been reduced. The Governor explained that he was not doing this because there was enough liquidity; but that is precisely why a cut in the cash reserve ratio would have had an important signalling effect without any risk.
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Thus, looked at in the context of the macroeconomic task facing the government, the slack season policy has been unduly conservative.
The same caution is seen in other, longer-term measures. Till 1992, banks did not have to record valuation losses on their holdings of government securities at all. In that year, they were made to mark 30 per cent of their securities to market. That percentage crept up at a glacial rate to 60 per cent last year. Now it is raised to 70 per cent, and the banks have been given notice that it would be raised to 100 per cent in three years. Complete marking to market would have a number of benefits: it would make banks sensitive to the risk of investing in securities, it would lead to the emergence of a more meaningful yield curve, and it would deprive the banks of hiding away their worst securities in the holdings valued at cost. This reform merits far more urgency than the Governor has chosen to give it.
This issue points to another which Reserve Bank has steadfastly ignored, namely the statutory liquidity ratio. Since the central government and its agencies ceased to take the benefit of the SLR, the SLR forces the banks to finance only the state governments. Irrespective of how badly their finances are run, the state governments in effect get automatic credit from the banks which they never have to repay; and whatever they borrow from the banks reduces by that much the credit available to productive sectors. Even Manmohan Singh, the great reformer, did not dare touch the SLR overmuch during his period of sweeping reforms. It is time to introduce a programme for abolishing it, and making the states compete in the market for funds; that would be a far more effective way of improving state governance than sending committees of enquiry into the finances of Rabri Devis government.
Another holy cow that Manmohan Singh did not dare touch was cheap credit to small-scale industry, in the form of subsidised interest rates on advances below Rs 200,000. Dr Jalan, to his credit, has attacked this shibboleth; now these advances will bear interest equal to the banks prime lending rate. The rise would not be significant since PLRs are hovering in the neighbourhood of 14 per cent; but at least a taboo has been broken.
Equally to be welcomed is the removal of the ban on granting higher interest rates on larger deposits. However, there is a danger that the banks would use this freedom to give sweeteners to favoured big depositors. This would be unfortunate and improper. The Governor should have specified explicitly that such higher interest rates should be publicly announced and payable to all depositors of sufficiently large amounts.
Concealed design
Taken together, the detailed changes announced do not present a breathtaking vista. But it is just possible that the bits and pieces conceal the workings of a grand design. For the governor did signal a weakening in his predecessors faith in money supply targeting. He noted that the demand for money was showing signs of becoming more sensitive to interest rates. He was very tentative on the implications of such sensitivity on monetary policy, and he has gone ahead and indicated a money supply growth target for the current year. But he did hint at using a number of indicators to draw policy perspectives. He may be groping in the dark, but at least he is looking for light. On these nebulous grounds, some optimism would be justified. It is to be hoped that he will last long enough to make use of the learning or better still, learn fast enough to put it to use.