FROM BUSINESS WORLD OF 15 AUGUST 2006
A frown from finance
Following its
quarterly review, the Reserve Bank of India raised its repo rate as well as its
reverse repo rate by 25 basis points on 25 July. State Bank of India, Punjab
National Bank and Bank of Baroda followed in its footsteps and raised their
lending rates. Other banks were following them when they received a letter from
the finance ministry telling them to take the approval of their boards before
raising rates; it was accompanied by a direction to the ministry’s joint
secretaries and directors to oppose a rise in rates by banks on whose boards
they represented the government. This caused some heartburn amongst banks,
which spilled over into the press. In response to it, P Chidambaram said on 5
August that the government was well within its rights as the banks’ owner to give
them directions.
Let it be said
at the outset that Mr Chidambaram is right – that as their owner, the
government is perfectly within its rights to tell the banks not to raise
interest rates. This is no infringement of their autonomy, for they have none.
They are under longstanding orders to give loans to farmers, small industry,
SC/STs and what not. They have incurred heavy bad debts by following such economically
irrational directives; and when they were on the point of failure, the
government has baled them out with subsidies. If such micromanagement by the
government is justified, there can hardly be objection to a direction on
interest rates.
One may well
wonder how this is Mr Chidambaram’s business, or why he is bothered. Interest
rates rise and fall; they are hardly something over which the finance minister
needs to lose his sleep. It would be foolish to say that interest rates are not
the government’s business, for it is by far the biggest borrower. But its debt
is so huge that it can never hope to repay it; and it can always borrow more to
repay the loans it has taken. So Mr Chidambaram is not batting for the
government as borrower when he tries to keep down interest rates.
But this is how
he wants to play. He is an interest rate hawk; ever since he became finance
minister, he has been promising that interest rates will not rise. If he wants
to keep his word, he can hardly be faulted for it, even if it is at the banks’
expense. He really, honestly thinks that low interest rates are good for the
economy. He wants the current economic boom to continue, and low interest rates
are the way he has chosen to keep it going.
One may well ask
why, if that is how he thinks, he did not simply ask the Reserve Bank not to raise
its policy rates, or even to reduce them. After all, the Reserve Bank is also a
part of the government; and there is a point in ensuring unity of command.
The answer can
only be guessed at, but it must be that the Reserve Bank may be a part of the
government, but that it is not a part of the ministry of finance. Although the
finance ministry remains its parent ministry, it has now grown up enough – or
been allowed enough freedom – to make up and say its own mind. Which it did in
the quarterly review: in its view, “Developments during the first quarter of
2006-07 indicate that money supply, deposit and credit growth are running well
above the indicative projections, warranting caution by all concerned in this
regard.” To put it plainly, the Reserve Bank feared that the economy was
overheating and that it was time to begin reining it in.
The Reserve Bank
gave figures to support its view; so it cannot be the case that that the
finance minister did not see its logic. Nor is it easy to suppose that he saw
the logic, but preferred to let the economy boil over. Every finance minister
hopes to see good times in his time, and none would want them to end, at least
till he steps down. But he would also not want simply to postpone inevitable
collapse. Mr Chidambaram must have in his mind a different way of dealing with
the risks perceived by the Reserve Bank.
If he does, the
way he chose is not the best. The finance ministry and the Reserve Bank, the
country’s two foremost economic policy institutions, take different views of
the risks facing the economy, and each decides to go its own way; that does not
inspire confidence in either. Ideally, they should have had a frank debate
amongst themselves and come to a considered course of action. If they could
not, the least one would like to ask is that they should explain themselves as
clearly and persuasively as they can to the public, so that it can make up its
own mind. The best assurance for robust policy lies in lively, informed public
debate; whether they agree or disagree amongst themselves, it is in the
interest of policymakers themselves to stimulate the debate.
