One of the most durable denizens of the government in Delhi was Bimal Jalan ; I cannot think of anyone besides Manmohan Singh who survived in the corridors of power for so long. Two things are required for durability in government: caution, which helps one avoid making mistakes, and amiability, which helps in making friends in the right places. Chacun à son goût. This assessment of his performance as governor of Reserve Bank was published in Business Standard of 17 October 2000.
IS HIS CERTITUDE CRUMBLING?
Times have changed. C Rangarajan used to use every credit policy statement to declare his liberal credentials and announce some liberalization measures. Today, Bimal Jalan reads out 20,000 words, whose only object seems to be to put the audience to sleep.
But that is not just because a different Governor is at the helm. Behind Rangarajan was a finance minister with conviction and authority to push reforms; behind Jalan is a finance minister whose heart may be in the right place but whose mandate is fragile; and behind him is a party with a strong backwoods element. So it is important for Jalan that he should not make waves. Which is why he specializes in underwater swimming.
But then, there is also less to report every six months. Ten years ago, Reserve Bank used to fix some 45 interest rates; and it used to control banks’ lending and investment policies in detail. So there were a lot of screws to tighten every six months. Now that those controls are largely dismantled, Jalan has so much less to do.
But there is also something personal about these colourless credit policy statements. Jalan sees that everywhere monetary policy is made from month to month, from day to day. Monetary policy has to react quickly to macroeconomic changes, which do not wait till April and October. So he too keeps changing rates whenever necessary; there is little to do at six-monthly intervals. So the credit policy statements have become progress reports and plan announcements. They have become more like a company chairman’s annual speech. Like many a chairman, Jalan could get away by spouting pious generalities. But he takes some pains to be concrete and to-the-point.
There are two areas where I found myself doubtful about what he has done and is doing – foreign exchange management, and organization of money and security markets.
Foreign exchange posed difficulties in the past six months. The rise in the crude price began to bite. Oil imports in April-July were $11 billion – twice what they were a year ago. And the US stock market melted in May. Speculators, short of liquidity, sold holdings in other markets, and other markets collapsed as well. FII investments flowed out. Foreign exchange reserves began to fall. In response, Reserve Bank raised the cost of finance to exporters and importers, raised the bank rate, forced holders of Export Earnings Foreign Currency Accounts to convert half their balances to Rupees, and halved the proportion of their export earnings that they could put into EEFC accounts.
Jalan is not entirely comfortable with what he did. He wonders whether it was right to use all these measures; would not just an increase in the bank rate have been enough? And also, should Reserve Bank watch the foreign exchange market all the time and react to its smallest hiccups? Has it been right to absorb foreign exchange whenever it was flowing in strongly? Would it not be better to let the Rupee appreciate in those circumstances (and, though he does not say it, let it depreciate when it is under pressure)? I suspect he would like to try it out. But he will not because of this passionate conviction he holds – that speculative movements in the foreign exchange market easily become uncontrollable and irreversible. He remembers how, in his early days, the Indonesian and Thai currencies were swept off in speculation, and Malaysia had to reintroduce exchange control.
Such traumas leave a deep impression, and the Governor of Reserve Bank cannot afford to take much risk. So he is unlikely to swerve from the path he has chosen, of shrinking the foreign exchange market as much as possible and micromanaging it. But I think he ignores the costs of his policies. The whole point of exchange liberalization was that many players – smugglers, NRI workers, big companies – were simply flouting exchange control with impunity; liberalization reduced the advantage they enjoyed and gave an incentive to everyone to be honest and law-abiding. Now that Jalan has shown that he can raid EEFC accounts for short-term advantage, companies will be tempted to keep their money outside and evade his net. Even if he does not see this point, he might see the advantage of increasing the spread – of allowing the Rupee to fluctuate in a band of 20 points, for instance. And also of basing intervention on the long-term trend of the Rupee, letting short-term speculation to work itself out. The general principle should be to meet fully the foreign exchange requirements for current account payments, and to change the exchange rate deliberately and steadily for improving or worsening the current account as circumstances require; capital movements, on the other hand, should be allowed to be reflected in day-to-day changes in the exchange rate. The rule will not be as clear to follow in practice, but as long as Reserve Bank has an up-to-date data reporting system, it can be made to work.
If he goes so far, he may even be prepared to concede that speculation can be as often stabilizing as destabilizing. If the Rupee goes down 20 per cent whenever FIIs try to sell their investment and take money home, they will think twice before doing so. Besides, anyone who sees the capital outflow is temporary will go long in Rupees. Both ways, the Rupee is will be more stable. So Jalan should try and bring back some speculators. His problem is that none of them is kosher enough for him.
In the domestic market, Jalan reintroduced ready-forward transactions, or loans backed by government securities, which RBI had banned in 1993 following the discovery of the bank scam. At that time repos were intended to finance interbank loans, but owing to slack supervision, they financed banks’ brokers who speculated with the money in the stock market. Now repos are for fixed, short periods; and since the transactions are computerized, Reserve Bank can keep track of them. But neither the repo nor the inter-bank money market has much turnover. So, much against its preference, RBI has allowed some financial institutions and nonbank financial companies into these markets; it hopes that one day soon interbank transactions will grow enough and it can throw out the other players.
This is a throwback to the days when Reserve Bank regarded itself a doting mother of banks and gave them all sorts of favours. This attitude is fundamentally flawed: Reserve Bank must aspire to be the maker of monetary policy, not the guardian of government banks. There is no reason to confine repos to government securities; they would work equally well against any company share. And if money market accounts are to come into their own, the overnight money market will have to grow by a multiple, and it can do so only if it is thrown open to many non-bank players. The only restrictions should be the size of minimum transactions and the financial soundness of the entrants. Nothing else matters.
