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.