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"The monetary policy is recognising the resilience exhibited by the economy ... " - Views on News from Equitymaster
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  • Oct 10, 2000

    "The monetary policy is recognising the resilience exhibited by the economy ... "

    An officer of the Indian Administrative Services, Dr Yaga Venugopal Reddy, has spent most of his career working in the areas of finance and planning both at the State and Central level. Dr Reddy, who has keenly pursued his interest in economic research, has been a Deputy Governor at the Reserve Bank of India since 1996.

    In an interview with Equitymaster.com, shortly after the annoucement of the monetary policy, Dr Reddy spoke about the economic developments and measures initiated in the policy itself.

    EQM: Inflation in recent weeks seems to have stabilized at around 6%. However, in coming weeks, as the oil price hike has been effected, significant price pressures could build up in the economy. How does the RBI plan to counter the same?

    Dr Reddy: As Governor Jalan has explained, what we have to look at is aggregate supply and aggregate demand factors and how they influence the inflationary path. And the second is the effect of shocks like the oil shock. We have to look at these two factors and in this context the policy statement is very clear. The endeavor of the RBI will be to maintain a stable interest rate environment, maintain appropriate liquidity while keeping a watch on other factors that may lead to uncertainties. Overall, implicitly I think, the monetary policy is recognising the resilience exhibited by the economy so far in absorbing the oil shock.

    EQM: In a related development industrial growth has slowed further in July. Higher rates to counter inflation may put further pressure on the industry, which has generated little investment demand. Consumer demand may also begin to ebb if oil prices were not to cool off. In such a scenario how will the RBI ensure an adequate flow of credit to the corporate sector without fuelling inflation?

    Dr Reddy: See I think everything is viewed in a context. One, inflation is rising, in the context of a supply shock, about which we do not know how long it will last. So therefore there is a conditional statement on the inflation. Similarly, in case of the industry the performance as well as the outlook in the current year is somewhat mixed. It is not appropriate to say that it is slowing down. So, it is a different type of a situation that is developing. But overall I think it is a matter of the general outlook of the economy in terms of GDP or in terms of inflation. It is marginally different from what was conceived earlier in April but most of the monetary parameters like money supply, credit and reserve money are expected to be on the anticipated trajectory.

    EQM: Even though there has been a slowdown in industrial activity, bank credit continues to be robust. How does this fit in?

    Dr Reddy: Again there are two ways to look at credit growth. We have deliberately indicated the feedback that we have received with regard of the sectoral disposition of the credit and monetary policy. But the definitive indications are that compared to last year the overall credit growth will be higher. The supplementary evidence is that the fiscal situation in reasonably comfortable. It is inappropriate to draw a conclusion that the industry is slackening significantly. It will be bold to make such a statement on the basis of whatever evidence that we have. At worst it is mixed.

    EQM: Do you see the rise in crude prices taking a toll on economic growth?

    Dr Reddy: Considering our country is dependent on imported oil to a large degree and the percentage of import bill accounted bill is rather large, the fact that oil prices have risen to the present extent, there will be a significant impact on the domestic economy. The global situation could also impact world output and this may impact the domestic economy. There will be definitely an impact on the economy. However, compared to earlier years we have one advantage, and that is the resilience that has developed both in the economy and the institutions to handle these kinds of shocks. And therefore, overall, there is cause for some concern but definitely not something to worry in terms of payment situations. We have clearly stated that the current account deficit will remain under 2%, which is a sustainable limit.

    EQM: The RBI has permitted banks to invest 5% of their outstanding credit in stocks and mutual funds, as against the earlier limit of 5% of incremental deposits. What was the rationale for this move? Would banks, which are still grappling with high levels of NPAs, be permitted to venture into the stock markets?

    Dr Reddy: Basically, what has been suggested is a rationalization. There seems to be an impression that there is a liberalisation. No, it must be made clear that what has been attempted as a result of the recommendations of the technical committee, is a rationalization of the procedure by which the banks are provided with the ceiling. Earlier, the ceiling was 5% of incremental deposits. Now what they have said is that the ceiling is now 5% of outstanding advances because investment in shares is an asset and therefore logically it should be linked to advances.

    All that the guidelines do is to provide a more rational way of defining the ceiling. And it is not liberalisation. On the contrary, because of the new ceiling there is scope for a large increase in bank investments, policy has clearly stated that the board should set an annual ceiling. And then any increase in investment should be gradual. So there is a sense of prudence. And each bank will have to fix its own ceiling based on its capacities of assessing the equity markets.

    EQM: You have been talking about resilience and so have the various RBI publications in recent months. The central government has been successful in getting a degree of control over the fiscal deficit and this has contributed to this resilience. What in your view are the threats to this possible correction in fiscal deficit?

    Dr Reddy: There are two different things. When we talk of resilience we refer to the resilience in the totality of the economic system, the economic agents, which are very much accustomed to fixed prices, inflexible situations like the administered pricing mechanism. So when we talk of resilience we talk of it in a systemic sense both in terms of markets and prices et cetera.

    But coming to the central fiscal situation the outlook, as indicated in the policy itself, the revenues have been very buoyant a compared to the past even as expenditures have been constrained. And there are only two uncertainties, one is the progress of disinvestment and second is the deficit in the oil pool account.

    EQM: What would you rate as the single most important initiative in the monetary policy statement?

    Dr Reddy: Well, in view of the subjects that I directly deal with, I would say the commercial paper (CP) guidelines that have been introduced are perhaps the most significant in terms of development of financial markets. Almost on an equal plane I would put the prudential measures with regards to banks.



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