For the last three years, the Reserve Bank of India has been fighting sundry fires. If in 1994-95, a sudden surge in forex inflows threatened monetary aggregates, then in 1995-96, the RBI was trying to contain the aftermath of easy liquidity. As a result, interest rates shot through the roof; the dollar-rupee parity went haywire and corporates all over complained of a massive credit squeeze. It took the RBI all of 1996-97 to restore a semblance of balance in the system.
Now that such distractions are finally out of the way, the RBI has taken time off from monetary aggregates. This monetary policy will be remembered for its wide-ranging institutional reform. Indeed, it is a big bang policy; perhaps the RBI has tried to make up for lost time. As regards the monetary stance, the RBI has chosen to continue with the broad money supply (M3) target of 15-15.5 per cent, commensurate with an inflation target of 6 per cent and real GDP growth of 6-7 per cent. The M3 target is marginally less than the 16.1 per cent growth in 1996-97, but expansionary all the same.
The RBI has tried to rationalise the M3 target by taking averages of the last three years. The fact, however, is that this period includes one year (1994-95) of 22.3 per cent M3 growth, a second year of abysmally low growth (1995-96: 13.2 per cent) and a third year with an average growth rate of 16 per cent. If credit growth does indeed pick up by 20 per cent, as projected, the liberal money supply expansion could lead to inflation shooting off at a tangent.
One thing is certain the numbers add up to a grand design. With deposit growth projected at Rs 80,000 crore (16 per cent), at least banks will have no paucity of funds to lend if credit growth does not pick up. One assumes the RBI has taken a calculated gamble between assuring availability of funds and the possibility of higher inflation.
But, to be on the safe side, it could not avoid a subtle sleight of statistical aggregates. It has said that banks investments in corporate bonds and debentures will henceforth be counted as bank credit. With that grand inclusion, bank credit growth is put at 20-21 per cent. Maybe there are good theoretical reasons for including bank finance in corporate debt instruments as part of bank credit, but once that component is removed from the growth figures, it is obvious that the RBI is looking at core bank credit increasing by only 15-17 per cent.
Amongst the changes that form a continuum, the RBI has further reduced the cost of deposits of less than one year to 9 per cent from the earlier 10 per cent. Almost 45 per cent of banks term deposits are supposed to be in this category. Banks are expected to pass on this benefit to corporates by way of at least a 50 basis point cut in PLR.
CRR has been brought back on NRE, FCNR(B) and NRNR deposits. That is fair as all liabilities, irrespective of origin, should be subjected to the same statutory obligations. NRE deposits have been brought on par with domestic deposits. The interest rates for deposits over one year have been freed and for tenures of less than one year, the rate is 9 per cent. Interest rates on FCNR(B) deposits have been freed altogether, subject to a cap laid by the RBI.
Dechoking channels
A determined effort has been made at revamping the entire credit delivery system. A legacy of the seventies, the concept of maximum permissible bank finance has been scrapped. Banks are free to determine the aggregate level of lending to their clients. Two points are important here. First, there is the oft-repeated doubt that banks may not be inclined to get out of the security and safety of MPBF. But this would be a suicidal course of action. Together with the scrapping of norms for consortium lending, the freedom is indeed with corporates to choose a bank which follows liberalised norms of lending.
To that extent, the measure to scrap MPBF is also a gentle nudge to banks to reform their credit appraisal and evaluation system. Corporates are now in the driving seat. With the consortium lending norms gone, they can go out in the market and obtain syndicated loans at prices that are negotiable. There goes the remnants of sanctity left in the concept of prime lending rate.
In fact, pricing of bank credit is no more a constraining factor as most banks have settled within the same price bands. Open-mindedness as regards funding levels is perhaps what will determine growth rates in individual banks.
Second, by scrapping MPBF norms, the RBI has pushed corporates almost entirely into the loan system of bank credit. The policy has only made marginal changes in the ratio of loan to cash credit components from the earlier 75:25 to 80:20 for corporates with limits of more than Rs 20 crore. But once corporates explore syndicated lending, they will have to shift entirely to a full loan system.
The next step in the RBIs liberalisation measures follows automatically by extension. It has opened up cash management avenues for corporates, in order to help them manage their short-term surpluses or shortfalls. Unlike in the cash credit system, corporates cannot park funds in the bank account or seek temporary enhancement of limits. For example, the minimum lot for banks certificate of deposits (CDs) has been reduced to Rs 10 lakh from the earlier Rs 25 lakh. On the other hand, the minimum tenure for commercial paper (CP) has been reduced to 30 days. Thus corporates have all the freedom, on either side, to manage their cash flows.
The benefits of scrapping the MPBF system have been well documented. What gives the measure a modicum of urgency is the fact that it will immediately release a large part of corporate borrowing limits. In the last two years, corporates had run up a massive increase in the stock of receivables. But due to the rigidities of the MPBF system, corporates were unable to get finance against the full value of receivables. Now that the focus on individual items under current assets has been replaced by aggregate level of bank funding, corporates can juggle their stock of current assets.
Yield curve
Equally important is the RBI attempt at identifying and supporting the development of a reference rate for the banking system. Till recently, the RBI was only talking of a rate to emerge from within the system. Many options were discussed, but nothing eventually happened. In the policy, the RBI has emphatically hoisted the Bank Rate (the rate at which the RBI rediscounts the eligible bill of the banking system) as the reference rate. All other interest rates in the system are being pegged to this rate.
Having done that, the next step for the RBI, of course, has been to kick start the development of a stable yield curve and a term money market. Statutory obligations CRR and SLR on inter bank liabilities has been scrapped. Banks can borrow across reporting Fridays without having to factor in the cost of pre-emption. Towards the development of an active Treasury Bill market, the RBI has announced auctions of varying maturities. Add to this the fact that the RBI has almost stabilised the system of three-day repo auctions, and it is clear that the RBI wants a stable yield curve to be guiding the amount of liquidity available with the banking system.
That is, it has made sure that banks and other institutions participate in primary auctions or in the secondary gilt market not simply to park investible surpluses but for genuine investment or trading reasons.
To begin with liquidity at the short end, the RBI has done three things. One, it has set up a general refinance facility available to all banks, at the bank rate. Funds to the tune of Rs 4,600 crore are available on tap, and each time for a period of four weeks. This should be enough to help banks tide over short term crises.
Second, it has brought back the institution of reverse repos which was discontinued after the scam. Though the number of institutions eligible for availing of this facility are limited, the fact remains that RBI has opened an unlimited window on short term funds. Three, more institutions have been allowed access to the call/notice money market as lenders; the only condition here is that they route their transactions through primary dealers. Banks have no paucity of short-term funds.
To that extent, volatility in the call money market (which reflected in the prices and yields of gilts) is a thing of the past. By extension, banks will not have any reason to salt away more funds to tide over a sudden surge in credit demand. The balance corpus of funds is now genuinely investible surplus. And once banks are certain as to the extent of permanently investible funds, they will shift attention to the gilts market. A stable yield curve only reinforces their commitment.
The RBI has made sure that banks and other institutions participate in primary auctions or in the secondary gilt market not simply to park investible surpluses but for genuine investment or trading reasons.
