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S. Venkitaramanan

THE RBI's Annual Report for 2001-02 tells a credible and creditable story of an economy well-managed, both on the domestic and external fronts, with reasonable price stability and a rate of growth that exceeds that of many other similarly placed countries.

The RBI's skilful management of the public debt market had enabled the successful conduct of the Central Government's massive loan raisings. True, the RBI has been helped by the robust growth of deposits in the banking system as well as the disappointing growth in credit off-take by the non-government side. But the successful conduct of the delicate task of monitoring the public debt of India at reasonable rates has honed the central bank's skills in the art of debt management.

In this context, it may therefore be inappropriate for the RBI to pursue its suggestion made in the Annual Report that the Government should take over the task of managing public debt, ostensibly to enable the central bank handle its monetary function unhindered.

Anyway, it seems inappropriate to create a parallel agency in the Government to handle a task that the bank has handled with remarkable dexterity in recent years. There is no certainty that a Government agency will do this job with equal skill. While the policy objective behind the suggestion is logical, it does not seem to be entirely compelling.

In a telling statement on the potential conflict between growth and inflation, the report points out that, sometimes, the fight against inflation can be carried too far. In the conduct of monetary policy, a central bank has to contend with the short-run growth-inflation trade-off.

The report notes that, just as inflation is harmful to growth in the higher reaches of the scale, there is a point up to which inflation may be neutral and even beneficial to growth, especially in developing countries, with unemployed resources for which moderate inflation can operate in a "greasing role".

Citing the Great Depression of the early 1930s, the report points out that while inflation can be unjust, deflation is inexpedient and the worse of the two. In its attempt to determine the target rate of inflation, the report cites the Chakravarti Committee's conclusion that 4 per cent would be a tolerable rate of inflation in India.

It points out that subsequent empirical studies have yielded estimates of the threshold in the range of 4-7 per cent. It also refers to studies regarding the sacrifice ratio as 2 for India. The sacrifice ratio is a concept that relates reduction in inflation to a linked fall in output.

A reduction in the inflation rate by one percentage point would reduce the output by 2 percentage points below its potential. While the report enters a number of caveats about strictly following this finding in its relevance to the current policy framework in India, it is relevant to underline the significance of the RBI's emphasis in not overreacting to the anti-inflationary objective.

Though the current trend towards low inflation in India is due to global supply conditions, particularly in respect of oil, it would not be inappropriate to infer from the RBI's remarks that it is inclined to "tilt" its policies towards growth rather than a blind pursuit of reduction of inflation. The report restates its policy aims as "maintaining price stability and ensuring adequate flow of credit in the productive sectors of the economy". Growth wins over deflation.

Turning to the external front, the RBI rightly takes credit for its role in the successful management of BoP. Not only has India escaped the contagion effect of the East Asian crisis, it has also successfully initiated various policy changes in the overall improvement of BoP, leading to a substantial increase in reserves, which stand today at more than $60 billion.

In its analysis of the causes for this improvement, the report gives due credit to the liberalisation of policies on the trade front as well as on capital inflows, as also on the general environment for invisibles. In fact, invisible receipts have risen to $14 billion in 2001-02 against $9.2 billion in 1998-99. This is due mainly to increase in receipts from software exports and remittances from non-residents abroad.

The total receipt on invisible account itself amounts to $35 billion in 2001-02, almost as large as the receipts from exports of goods at $43.56 billion. But export of goods still commands the lion's share of attention from the mandarins of New Delhi.

The growth in reserves to the current $60 billion gives the economy sizable room for manoeuvre, especially in the context of developments such as drought. The policy of the RBI in keeping high level of reserves stands substantially vindicated by the increased international confidence in India's financial management. Safety, however, comes at a cost.

The RBI's accounts show that the net earnings on foreign currency assets work out to 4.1 per cent in 2001-02, a fall from 5.8 per cent in the earlier year, primarily on account of global decline of interest rates. These rates are low compared to the costs we bear on our ECB and NRI deposits. The management of high forex reserves, therefore, causes a loss when returns on their investments are less than the rate of interest we pay on external debt, especially at the margin. This loss is, however, incidental to the cost of increased security offered by the high level of reserves.

The RBI report points out that considering the volatility of the various capital flows, the expected debt service payments and other commitments are to be considered just sufficient. Opinions can differ on the exact level of security chosen by the central bank. But, broadly speaking, no price is too high in a world open to contagion and high volatility in the exchange market.

In this context, it is noteworthy that the central bank has taken pragmatic steps to allow corporates to repay high-cost external commercial borrowing. This is part of the overall liberalisation of transactions on the external account.

So far as exchange rate management is concerned, the report is constrained to be opaque. It merely re-emphasises India's policy of focussing on managing volatility with no fixed rate target — a policy that has stood the test of time. It assures that the RBI will continue to adopt the same approach of watchfulness, caution and flexibility.

Turning to banking activity, the RBI report notes how the non-food bank credit to the commercial sector has slowed down. It notes that the main factors for the slowdown were the downturn in the medium and large-scale industry sectors. Specifically, credit demand has slowed significantly in cotton textiles, infrastructure and petroleum — part of a generic macro-economic problem about whose solution the report makes no suggestion.

Turning to agriculture, the report notes the shadow cast by the threatened drought. It notes that the much-needed diversification of agricultural production needs substantial public investment, particularly in irrigation and agriculture, a point that the policy-makers have to take note of.

The fiscal and monetary implications of excess foodgrain stocks, especially the fiscal burden on account of growing food subsidy, call for specific actions. In this context, the report refers to a report of the Administrative Staff College, Hyderabad, suggesting a multi-pronged approach for orderly disposal of stocks, avoiding major possible implications at the harvest time, a minimum support price in relation to market price, and a long-term strategy of diversification in agricultural production.

Apart from comments about India's economy, the Annual Report is significant for the information it gives on its own working. Thanks mainly to the large forex reserves and considerable borrowing by the Government, the accounts of the central bank show a healthy picture.

In 2001-02, the RBI had a total income of Rs 24,690 crore, made up of returns on foreign assets as well as domestic assets. Income from foreign currency assets is of the order of Rs 10,000 crore, while the balance Rs 14,000 crore is accounted for by earnings from domestic assets, primarily Government debt to the RBI.

Of the total profits of Rs 24,690 crore, the RBI has planned to transfer nearly Rs 7,800 crore to reserve funds, leaving a net income of Rs 16,866 crore. It is pertinent to point out that the appropriateness of keeping such large provisions for contingency and asset development reserve must be subjected to continuous review both by Government and the RBI. The appropriation of the net disposable income of the RBI for 2001-02 is seen in the Table.

Of this disposable income, RBI proposes to transfer Rs10,320 crore to the Government. This is a sizable boost to the frayed revenue account of the Government. Obviously, it could be higher if the transfers to reserves are kept at a lower level. Overall, the RBIs Annual Report for 2001-02 presents a credible story of substantive and creditable achievements on financial management.

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