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Jalan's new monetary instrument

It was an unusual Bank Rate 'cut' that the Reserve Bank of India announced in its Monetary and Credit Policy on April 29. Specified the quantum precisely - a half percentage point -- but does not say when it takes effect! Hedges it with several ifs and buts.

A new monetary instrument is thus born - a deferred Bank Rate change. Designed with the ostensible purpose of introducing transparency.

A Bank Rate is at which the central banking authority, as a lender of last resort, gives accommodation to accredited financial intermediaries and determines the cost of funds in the economy.

Normally, Bank Rate changes are made after the banking hours and take immediate effect. Otherwise, one can take advantage of it, make pecuniary gains if the interregnum is long. Also, a surprise element is built into.

Even in the US, an advanced country where economic analysis is sophisticated, the nation waits with bated breath as its Federal Reserve assembles to ponder that nation's economic health.

The assumption is that monetary authority has access to information not available to others and is vested with greater wisdom than the public at large.

In his statement, the RBI Governor Bimal Jalan says "....a reduction in the Bank Rate by up to a half percentage point (50 basis points) will be considered by RBI as and when necessary." No timeframe set.

The first stipulated criterion is that inflation rate should remain low. Then the overall liquidity and credit situation should warrant such a step.

Traditionally, six months from May are slack season when prices tend to rise. But now such an apprehension is tempered by opening up of the economy and emerging free trade in commodities.

Supply management is the key to control prices. On the demand side, the proposed 0.5 per cent cut in the cash reserve ratio of banks from June 15, will add Rs 50 billion to liquidity.

Jalan does not want to tread on the beaten track. Has a penchant to do something new, something different from his predecessors.

Over the past two years, he has been saying he intended to make the Credit Policy a 'non-event.' And now, a deferred but uncertain Bank Rate cut.

And, what is this 'credit situation' the governor is talking about? Over the past couple of months, demand for bank funds is inching up, which is attributed to an industrial revival.

Apparently, Jalan expects a surge in demand for credit from agriculture, industry and trade as economic growth accelerates.

The projected gross domestic product growth is 6-6.5 per cent this year against 5.4 per cent last fiscal and 4.7 per cent the previous year. Which means enhanced fund requirements.

The Centre's market borrowing programme coincides with the projected credit surge. The RBI has to ensure that banks have adequate cash to make that programme a success and oil economic growth.

There is at present a large liquidity overhang and as a sequel banks have parked their surplus cash in what is called the RBI 'repos'.

The RBI governor expects the excess liquidity to disappear even after Rs 50 billion are pumped into the system by the 0.5 percentage point cut in CRR from June 15.

Once Jalan's three criteria of inflation, overall liquidity and credit situation are perceived to be satisfactory, the RBI will probably take the plunge: lower the Bank Rate by 0.5 per cent to 6 per cent.

If at all the rate cut is to be a reality, it should happen within 12 weeks - well before the mid-season review of the credit policy starts. The Reserve Bank is supposed to be proactive, review the monetary situation constantly, act before the horse bolts - and act quietly.

What is Jalan seeking to achieve by putting his thoughts in black and white now? Is it a signal to banks that they should view any tinkering with the coupon rate in the Centre's market borrowings in that perspective?

Or is it also a signal to Finance Minister Yashwant Sinha that the RBI is still in favour of soft interest rates though the Bank Rate cut was not on the April 29 menu?

The latter is subtle, but more important. Sinha kicked up a lot of dust by presenting a tough Budget, saying in effect no more gambles please, and intended to mobilise what he considered the required resources to maintain fiscal probity. Subsequent partial rollbacks have left many unhappy.

A Bank Rate cut at this juncture would have fuelled the Sangh Parivar's ire over the raw deal to the middle class, which is yet to reconcile to the falling interest rates. On the other hand, Jalan's silence on the subject might have angered Sinha.

Jalan wanted the dust to settle. He opted for the stratagem of talking about the rate cut and softening interest rates (and please Sinha) but little immediate action on the ground. In the process, he broke conventions, raising many eyebrows.

I had said two years ago that Jalan's style is to let the sleeping dogs lie. Now he awaits patiently for the dogs go to sleep and then cross the bridge when he comes it.

The moment of reckoning may arrive in July-August when expectations over the monsoon rains and kharif rule the roost and drive the price trends.

If everything goes Jalan's way, he may advance the CRR cut from June 15 and even opt for another CRR cut - may be a quarter percentage point again to show that he is unconventional - and make the promised Bank Rate cut a reality.

Floating versus Fixed Rates

Curiously, here in India, we are talking about cuts when the rest of the world is either put them on hold or looking for a U-turn in interest rates. In the US, for instance, the talk is on the timing and extent of interest rate increases.

The anticipated revival in economic growth, translated into credit demand, would in fact point to the need for a U-turn here too. India is not the rest of the world. This economy has its own characteristics, which have to be reckoned with.

But that threshold is not far away. May be four months to feel the growth impulses loud and clear.

Then Jalan's wish of bank customers switching to floating interest rates from fixed ones at present would certainly be fulfilled.

It's unnatural for customers to shift away from fixed rates when they perceive the deposit rates are falling. They would certainly lock in at the existing levels for periods as long as possible.

Bank staff encourage depositors to opt for long-term deposits so that their paper work is reduced. Despite computerisation.

If depositors perceive a reversal in the falling trend, they will insist on either very short-term maturities or opt for floating rates if banks offer.

Depositors should watch out.

A great relief for Sinha too. But that situation is still some way off.

Journalist R C Murthy had senior editorial assignments at the Business Standard and was a correspondent of the Financial Times, London. He also writes for several financial journals.

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