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Reddy Has Got It Just Right

 Omkar Goswami


Dr Yaga Venugopal Reddy has never been a professional banker. A career civil servant, he had some experience of banking and finance when he was in the charge of the Department of Banking in the 1990s. His first stint at Mint Street as a Deputy Governor under both Dr. C. Rangarajan and Dr. Bimal Jalan gave him his first ring side view of central banking. And he proved himself to be a rapid learner.


I still remember an occasion where he was addressing a conference of foreign exchange traders in Goa in August 1997 when he virtually talked down the rupee. In fact, if you were to track the daily rupee-dollar exchange rate from the early 1990s, you will see a sharp, discontinuous fall in August 1997, after which it continued going resolutely south till it breached the Rs.40-mark. That discontinuity had much do with Dr. Reddy’s ruminations in Goa.


At that time, many people disliked what the Deputy Governor did, and said that if a central banker had to speak at all, it had to be done so elliptically that nobody knew the import of anything. It is not as if Dr. Reddy is a paragon of clear and unambiguous speech. Most of his public speeches are sufficiently oblique, abstruse and parenthetical, and he therefore certainly makes the grade as a speaker representing a central bank. Despite all his circuitous sentences in Goa, he succeeded in exactly what he set out to do — to quietly talk down the rupee-dollar exchange rate at a time when Asian currencies were being mercilessly hammered because of the financial crisis. With just about $30 billion in foreign currency reserves, the RBI could ill afford to maintain an exchange rate that was getting rapidly over-valued. Someone had to start a decisive southward movement. Dr Reddy did it with his Goa speech.


The point I am trying to make is that Dr. Reddy may not be as academically distinguished as Dr. Rangarajan or as smooth and as instinctive a player as Dr. Jalan; but he is a good central banker who thinks a great deal before acting, and generally makes the right moves.


That shows up in the RBI’s recent annual policy statement. Whatever the government may claim, the fact is that there are inflationary expectations. By artificially keeping a lid on retail prices of diesel and petrol, the government is trying to do what it possibly can to prevent the full inflationary effect of crude price hikes to pass through to consumers. But in a milieu where nobody can say how crude oil prices will behave in 2005-06, and with there being no serious reduction in prices to what energy experts term as the “natural equilibrium level” (whatever that might mean!), there are limits to how much longer the government can hold the fort. Moreover, given the track record of successive governments in the inability to cap deficits, there is no reason to believe less in the very first month of a new financial year that the North Block will, indeed, keep its borrowing programme under control.


Small wonder then that the RBI is concerned about inflation. When it speaks of an inflation rate of 5 per cent to 5.5 per cent in 2005-06, “subject to the growing uncertainties on the oil front”, the RBI means that we are probably looking at a point-to-point inflation of 6 per cent or more.


The RBI could not have turned a blind eye to such a situation. Equally, it couldn’t have made moves that would permanently spook the markets and harden interest rates to a point where they put a brake on 7 per cent plus GDP growth. So, Dr. Reddy has chosen the soft, signalling option. By increasing the reverse repo rate (at which banks park their excess short term funds with the RBI) from 4.75 per cent to 5 per cent, he has indicated that the financial sector ought to be prepared for a possible hardening of interest rates. Equally, by leaving the bank rate unchanged at 6 per cent and limiting the spread between the repo and the reverse repo rates at 1 percentage point, Dr. Reddy has signalled that he doesn’t want to affect growth, and won’t apply a tight squeeze yet. Basically, what he has said goes thus: “Listen guys. I am just adjusting your pajamas a teeny-weeny bit. If inflationary pressures ease off, so will I. But if these intensify then expect me to start tightening the draw strings”.


So that there aren’t too many skittish reactions, the RBI has also thrown in a fair amount of goodies. Indian companies can now invest up to 200 per cent of their net worth in overseas JVs and subsidiaries — which is a doubling of the limit. Moreover, listed companies have now been allowed in repo transactions. While this may, at the margin, move some corporates away from liquid or money market mutual funds, it will create a wider and more diverse repo market, which is a good thing. Trading in gilts have been made easier. And banks have been allowed to approve proposals from their corporate customers for commodity hedging in international exchanges.


All said and done, however, the RBI seems to be anticipating an inflationary year and therefore wants to signal that it has the option of hardening interest rates, if need be. It doesn’t mean that the mid-term announcements in October will necessarily see higher interest rates. That would depend on the liquidity overhang, growth prospects, government borrowing and what happens to inflation in the first six months. Dr. Reddy has signalled his disquiet and has taken a tiny step to show that he may mean business. He has spoken softly, but told everyone that he carries a big stake. That’s exactly the axiom of Teddy Roosevelt that central bankers strive to emulate. In this, despite not being a professional banker, the good Dr. Reddy has struck just the right note.   


 Published: The Economic Times, May 2005


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