In its latest annual report, it is a bit surprising that the Reserve Bank of India (RBI) has not taken due credit for anticipating emerging global issues and for taking correct pre-emptive action.
Instead, RBI has reiterated concerns that it has expressed for some time now: about the rapid and excessive inflow of foreign capital and consequent accumulation of foreign exchange reserves, the resulting overhang of liquidity in the system, the massive expansion of credit this excess liquidity has facilitated, and the increasing direction of such credit to risky or “sensitive” sectors, especially housing and other real estate.
Lest its correct calls bring about policy complacence, RBI has, quite significantly, all but washed its hands of the emerging problems should it be left to handle these on its own.
This amounts to, by far, the clearest exposition by the central bank that its quiver doesn’t have very many policy arrows to control the age-old demon of inflation, along with issues of credit quality and financial stability in a liberalized economy that is not completely financially intermediated at a time of global uncertainties.
It is not far-fetched to say that in such a situation, for RBI to err on the side of stability rather than change will be a grave error. But that is precisely what it seems to be doing.
What the system requires is not a directional change that RBI seems to be obsessed with—from freer liquidity to tighter liquidity; or in the pricing of credit from less expensive credit to more expensive credit—in a generic sense.
Instead, the need is to ensure some decisive allocative changes within the money markets and across asset types, which will not impair growth, but will change the composition of credit that RBI is worried about.
None of these find any space in the annual report.
RBI has achieved what it has done by not merely signalling that credit must be restrained, but by almost going overboard and started selective sectoral credit control by calibrating the provisioning norms. In fact, the central bank, by restricting its lending to the government and undertaking open market operations of various kinds, has been seeking to limit the growth of liquidity in the system.
Yet, there has been an increase in liquidity, because of the surge of capital flows into the country. This has made RBI intervene in the foreign exchange market openly and aggressively. Now, it has little manoeuvrability left on this front. The net result has been an increase in liquidity in the system, a consequent credit boom and the growing exposure to sensitive sectors and subprime borrowers.
Both the volume of credit and the distribution of that credit have substantially increased risk and the threat of financial instability. Now, its hands are increasingly getting bound. RBI is clearly seeing the capital inflows as merely more than a monetary policy nuisance.
The manner in which it correlates various facts—that India is the only emerging market economy which combines high inflows with a current account deficit, along with a significantly high trade deficit—it is evident that vulnerability to global woes is a macroeconomic, and not just monetary, reality.
The real problem is that RBI itself is not clear on the way out. It is obvious that capital outflows can be incentivized and, in a half-hearted manner, RBI even advocates that. It just isn’t going all the way.
At best, this RBI annual report is an admission of its limited capability in manning the new set of issues emerging out of liberalization and their impact on monetary policy management. When this inability is contextualized in the larger policy picture, wherein the post-reform economic regime monetary policy interventions are the only policy instruments available with the government to address short-term aberrations and medium-term problems in the system, it is a worrisome state of affairs.
The reality is that all other policy instruments have either been abolished or have been limited by the process of economic reforms.
It is time now for evolving monetary policy instruments for these times. It is time the central bank made up its mind, even if it means treading on someone else’s shoes, and those shoes happen to be the rather large shoes of the Union government.
(Haseeb A. Drabu is chairman and chief executive officer of Jammu & Kashmir Bank Ltd. These are his personal views. Send your comments and views about this column to email@example.com)