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Why RBI policy may not hit common man

October 28, 2009 13:36 IST
The worry that inflation may rise again and dominate the economy is high on the minds of the RBI team. This has prompted them to rein in their ropes just a bit.

The global financial crisis and RBI

When the entire world, was in a crisis with their financial institution, only a few large countries escaped the mayhem. India is proudly a part of the elite countries that escaped the crisis that is still continuing in several large economies. Over a hundred banks in USA alone have downed their shutters due to this crisis.

The reason the Indian financial institutions survived is because of the conservative policy of RBI. In RBI's own words, "India has been less affected by the crisis than most other countries because of our relatively cautious policies, prudent regulation and effective supervision". Nonetheless, there are lessons from the crisis for India too , which include:

  • Further strengthening regulation at the systemic and institutional levels.
  • Making our supervision more effective and value adding.
  • Improving our skills in risk management.

Inflation in India - Round TWO

The first round of high inflation that happened in India in the year 2007-2008 was because of the global oil prices and because of the industrial inputs like steel and copper. These may not affect the common citizens on a daily basis. The prices went up because of the short supply of these items.

The current round of inflation (round two) is caused by the increase in prices of food and other items that directly affect the Aam Aadmi. Again the reason for the jump in prices is because of the short supply of these items due to either too much rain or deficient rain.

As per RBI data during the current financial year (up to October 10, 2009), the increases in prices of wheat (3.5 per cent) and rice (5.9 per cent) were relatively low as supply side pressures were mitigated by the comfortable levels of food grain stocks with public agencies which stood at 44.3 million tonnes as on October 1, 2009 as against the minimum stock norm of 16.2 million tonnes.

However, large increases were recorded in prices of vegetables (59.3 per cent), tea (30.7 per cent), sugar, khandsari and gur (28.7 per cent), egg, meat and fish (25.3 per cent), pulses (19.2 per cent), jowar (14.9 per cent), condiments and spices (14.2 per cent), milk (7.0 per cent) and fruits (5.2 per cent). Again the prices have gone up due to short supply of these agricultural products.

RBI's role

There are possibilities that with a good monsoon the next time around, the supply of agricultural products will pick up once again. This will reduce the inflation to controllable levels.

For now RBI has taken measures to control inflation to some extent. Based on the argument given by RBI, they think that controlling inflation is more important that providing more money supply for the economy.

The decision by RBI is thus to exit the policy of excessive money supply. Though the decision is to exit, they are also aware (as per their report) that too much of tightening of the money supply in the economy may hamper the economic recovery caused by the global financial crisis.

This has caused RBI to only modify certain aspects of the liberal money supply policy.

Effect on the common man

The monetary policy will not affect the common man directly in the near future. The increase in the SLR (to 25 per cent) does not have any impact as the scheduled commercial banks are already having the SLR at 27.6 per cent.

The Reserve Bank of India has commented on the wide gap among banks' provisioning coverage ratio and has advised banks to augment their provisioning for the non-performing assets. NPAs are those loans which the bank is not able to recover. Provisions are that part of the profits that need to be set aside to compensate for the unrecoverable loans.  

In specifics, RBI has said banks must keep at least 70 per cent provisions. This will affect a few private and PSU banks who have a lower provisioning currently.

The tightening of export credit will not have any effect on the common man.

Removing the bank lending support to mutual funds may have an effect in the short term if the stock market takes a downward trend. The bank lending support was given to mutual funds in the first place to meet their requirements to give money to the large number of people who wanted their investments back. If the stock market falls again and mutual funds do not have the support, long term investors will be affected. The argument of course has a large number of 'Ifs' and 'Buts', which may not happen.

Summary

The monetary policy can be looked at as a conservative step. It remains to be seen whether this step is in line with the conservatism which protected us from the global financial crisis or one to slow the recovery process.

For the common man though there is no major positive or negative impact from the changes that RBI has made to the monetary policy.

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