| A degree of monetary tightness is creeping in, conjuring up images from the nineties, when the Reserve Bank stepped in to curb inflation and maintaining macro stability. This was followed by a long period of decelerated growth, something from which the economy has truly recovered only in the last three years. With a new credit policy about to be unveiled and a certain amount of noise about money getting tight, there is some concern over the future of growth. Its momentum and supporting sentiment should not be sacrificed at the altar of monetary conservatism. This attitude was best captured by what the then high priest of conservatism, S S Tarapore, used to say: It is the duty of the central banker to run away with the punch bowl just when the party is warming up! |
| The approach of the central bank is now vastly different and a similar across-the-board tightening is not anticipated. But it is useful to go over the basics to assess the similarities and differences between the situation today and what prevailed around a decade ago, if only to have a clearer grip on what needs doing and what does not. |
| The obvious place to begin is inflation. It clocked 12.6 per cent (wholesale index) in 1994-95 and thereafter steadily came down to 4.6 per cent in 1996-97. On the face of it, the current inflationary situation poses no problem with the index running at a bit above 4 per cent. But the catch is that the government has not passed on the full impact of the rise in oil prices. How long can the government go on issuing oil bonds to the oil-marketing companies, it is asked. The contrary view is that global oil prices have peaked and the Indian system has been able to absorb the latest oil shock remarkably well. The coming year may see a mixture of partial absorption and marginal rise in the inflation rate, as has happened over last year, with the headline rate coming down over time. The price situation appears manageable without any monetary tightening. |
| The next issue is whether there are asset bubbles""notably in property and stocks. The real estate situation in the country is mixed. Property prices have shot through the roof in Mumbai and Gurgaon. In the rest of the country also there is a steady upswing but not a runaway rise, particularly not for non-prime properties. A rise in housing loan rates will most adversely affect the less well off among the middle class. Instead of causing rates to go up across the board, it may be a good idea for the central bank to ordain differential lending for the first apartment someone may acquire. A system of exchanging credit information among banks is in place, which can let banks identify if an applicant already enjoys bank finance for housing and charge sharply higher rates for a second property. As for Mumbai and Delhi (Gurgaon feels the impact), everyone knows what really needs doing""open up land supply, not raise interest rates. |
| Stock prices seem to be on a runaway spree, fuelled by consistent foreign inflow followed by small investor enthusiasm typical in the later stages of a bull run. There are already strict checks in place to regulated bank lending against stocks. The important difference with the early nineties is that then a lot of funds raised by companies found their way into property and stocks instead of investment in new capacity. Currently, robust business confidence is not only leading to capacity expansion at home but acquisitions of capacity abroad. |
| The business confidence stems partly from strong demand for consumer durables funded by bank lending, which seems to be going on merrily and is not affected by the new caution now governing housing loans. Thus, the stock market is dancing to its own tune and seems to be headed for a substantial correction, maybe on the back of the earning numbers, which are beginning to trickle in. A general monetary correction, which will adversely affect the booming investment climate, is not the answer. |
| The RBI's position is that liquidity conditions became tighter from mid-December 2005 due to IMD redemptions, build-up of government of India cash balances and sustained credit growth. Since then the central bank has put in much more than went out via IMD redemptions. Plus, the RBI's foreign exchange operations and private placement of government paper also have had a positive impact on liquidity. Call money rates, which had gone up, have eased. But if banks lend like crazy, the money has to come from somewhere. The incremental credit-deposit ratio, additional credit given as opposed to additional deposits garnered, has been more than 100 per cent for two consecutive years. That is, banks are lending more than Rs 100 for every Rs 100 taken in as new deposits. |
| The RBI expects banks to take action to raise deposit growth. Presumably by raising deposit rates. If lending rates don't simultaneously go up what happens to their spreads? The Left- supported government at the Centre can hardly tell public sector bank managements to cut costs and live with lower spreads. Right now SBI employees are on strike over better pensions. |
| The overall message from the RBI is that it has not gone in for serious liquidity correction. But we have to wait for its precise monetary policy stance. Right now, it is asking players to cool things a little. The best course ahead seems to be to go in for sectoral regulation instead of using a blunt instrument like raising interest rates across the board, which affects the economy and overall sentiment. Hopefully, the punch bowl will not be taken away altogether and it will be partly refilled, for example, by lowering the CRR. |
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