The Hindu Business Line : Will Dr Y.V. Reddy surprise?

THE markets are eagerly awaiting Dr Y. Venugopala Reddy's maiden Credit Policy statement as Governor. It is only appropriate to point out that Dr Reddy is not a new hand at the game. He had left his imprint on a number of Monetary Policy statements during his long tenure as Deputy Governor of Reserve Bank of India. His valuable contribution to the evolution of Monetary Policy during the last decade has to be acknowledged when one assesses the impact his gubernatorial tenure will have.

To be sure, Dr Reddy as Governor will be more assertive than Dr Reddy the Deputy Governor, but his persuasive powers, whatever be his position, are too well known to need reiteration. We await Dr Reddy's second coming, in his capacity as Governor, rather than a radical change.

This said, it follows that Dr Reddy will not make any sharp departures from his predecessors, however different the style and the presentation may be. The substance of policy seems set to follow the broad scheme outlined and effectively implemented by his brilliant predecessors, particularly that of Dr Bimal Jalan.

Still, observers can be excused for expecting some dramatic tilt — in terms of interest rate policy, preemptions or exchange rate management. Such expectations are unlikely to be fulfilled, given Dr Reddy's well-known track-record of pragmatism and instinctive dislike for "rocking" the boat.

Dr Reddy will hopefully follow Dr Jalan's highly appreciated approach of demystifying the policy and of making it less of a media hype than it used to be in the old days. It is just a periodic visit by the central bank to the fundamentals of the country's economy. No mystery there, no sacred rites or hocus-pocus.

Guesstimates abound on what Dr Reddy would do, come judgment day. Will he lower the bank rate, the repo rate and the cash reserve ratio (CRR)? These are the critical variables, which the central bank can operate on. In addition, there is guidance, which the bank's review of the economy will give. What will it disclose about the Governor's intentions?

Turning to the interest rate, it is a fact that the interest rate is at an all time low. With rising inflation, the real rate of interest is treading dangerous negative ground. There does not seem to be any justification for lower interest rates further. I do not see the Governor trying to depress interest rates further.

Experts have, however, written tomes about the need to get a steeper yield curve. How exactly the central bank will achieve this is a matter of technique rather than policy. Dr Reddy is no stranger to the techniques of management of interest rates, particularly the repo, to achieve this. He has also the weapon of open market operations, which the RBI is becoming more and more expert in.

That the regime of low interest rates — both at the short and the long end — is, in part, responsible for the booming economy, especially the better corporate results, is known. The availability of funds at relatively low rates has definitely had a favourable impact on the bottomlines of many corporates.

It has played a part in the stock market boom as well as in encouraging construction, particularly housing, which have helped sustain the growth of the economy. I believe that notwithstanding the likely adverse side-effects of a soft interest stance in encouraging speculative finance, Dr Reddy will not attempt to change the bank rate. In my view, he will confine his intervention to the repo rate from time to time — an operation in which the RBI can respond to changing money market conditions.

As for CRR, I do not see any justification for the Governor to tinker with it. There is, in fact, too much liquidity around, which means a reduction in the CRR is not called for. By the same token, Dr Reddy may not like to squeeze out excess liquidity by raising the CRR. He has instruments aplenty, in terms of open market operations to do that, if circumstances justify it.

The gnawing question is what Dr Reddy proposes to do with the nagging question of fiscal balance. I believe he has to take as given the fiscal imbalance at the Centre and the States. He may lecture the government on fiscal propriety, but I do not think he will resort to punishing it by raising the costs of fiscal misbehaviour, namely interest rates.

That will be negating the entire trend of policy reform, which Dr Reddy himself had initiated, particularly in his earlier avatar as Deputy Governor, in regard to government borrowing, especially in the shape of small savings.

The question of handling the appreciation of the rupee — which apparently hurts exporters — still remains. There is no easy solution to this issue. The current account is in surplus, thanks mainly to service exports and capital and other remittances. There is an excess supply of dollars. The dollar inevitably gets cheaper versus the rupee.

There are different ways in which the central bank tries to handle this crisis of abundance. But none of them will obviate an ultimate appreciation of the rupee. Dr Reddy is fully aware of the policy options and their contradictions. A feast of dollars seems his fate — a fate which will soon carry the country well past the century mark in terms of foreign currency assets.

Whether this means that Dr Reddy should try to put a damper on the flow of capital into the country, or whether he should encourage outflow by liberalising capital transactions is beyond the remit of his forthcoming policy, but will challenge his attention for the rest of his term.

Obviously, the appreciation of the rupee has one unintended and undesirable consequence. It increases imports and makes exports unattractive, both undesirable outcomes from the overall economy's standpoint.

A point will come when Dr Reddy and his remote controllers at the Ministry of Finance — they do exist in spite of the RBI's independence — will have to ponder for how long our investment-starved country will pump out funds to developed countries instead of helping to sustain investment in our own economy — which is what increasing reserves mean.

But the answers may not lie in the forthcoming monetary policy, but rather in the forthcoming Budget of Mr Jaswant Singh and its orientation and implementation.

There is a great deal of structural reform, which still calls for the attention and focused action by the RBI. There is a disconnect between the lower interest rate regime and the interest rates which small and medium scale industrialists are getting.

There is also need to speed up the legal reforms on which his predecessors had initiated a valiant effort, with the Securitisation Ordinance. The corporate debt restructuring process is still very much in a state of experimentation. Many participants do not seem to appreciate the need for urgency in the process. Enterprises will die if denied the oxygen of credit and this will set the creditor institutions in further jeopardy than before — with larger non-performing assets, which cannot be recovered from a "dead" enterprise.

Exporters have also a slew of complaints about the credit structure, especially the declared rate of interest at which credit is not available from banks. Dr Reddy needs to carry forward interactions with exporters and try to solve their problems. Above all, he needs to stir up the "long-term lending" in the financial system.

Unfortunately, the demise of long-term lending institutions came as a result of the reform process. It has left a vacuum. We need to recognise and solve the problem of lack of adequate long-term finance. Unless this problem is solved, the country will not get the spurt of investment it needs in the private sector, which is vital to catch up in terms of productivity and competitive efficiency.

An equally important dimension is the need to speed up investment in the rural sector. Dr Reddy needs to revisit the Rural Infrastructure Development Fund and the cooperative financing structure — to see how they can be reactivated and revitalised. All this is an agenda, which can well occupy Dr Reddy's full tenure as Governor. But he can make a start in his ensuing monetary policy announcement. That is the least we expect of Dr Venugopal Reddy.

That the country needs to go ahead on the path of increasing investment — particularly in infrastructure — is a message that many analysts have proffered the central bank and the government over the years. The monetary policy will be judged by how successful it is in stimulating the impulses for growth that are just becoming evident in the economy.

The monetary policy should be complimented if it does nothing to disturb the animal spirits of enterprise, which we sorely lack and are just seeing evidence of in the public as well as the private sectors.

The touchstone of Dr Reddy's policy will be whether it be directed towards interest rate, liquidity enhancement or exchange rate management with this aim in view.

Let us hope that Dr Reddy will "surprise" the markets by doing more — by a bouquet of growth-oriented measures which keep growth with stability in mind.

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