S. Balakrishnan

It was no surprise. The Reserve Bank of India increased the cash to be kept by banks from 7 per cent to 7.5 per cent in its half-yearly review of Monetary Policy.

This earns no interest and, therefore, indirectly pushes up their effective cost of funds. No respite for borrowers, it would seem from the CRR hike.

The Government and the RBI are already bearing a huge burden in soaking up the excess liquidity in the banking system arising from the valiant efforts of the latter to arrest the rupee’s rise.

(That, in turn, is the result of the ‘flight of capital’ – if one may call it that – from the First World to emerging and ‘incredible’ India).

The Government pays interest on the sterilisation bonds designed to mop up liquidity without access to the proceeds of the bonds. The RBI is (kindly) paying interest to banks at 6 per cent on their surplus funds (but for which they would earn nothing on them).

To the long list of subsidies – deserving and undeserving – must now be added these (gratuitous) debt-servicing costs. It is farce of a high order.

Here is a large and rapidly growing economy becoming a giant on the world stage in crying need of quality physical and social infrastructure reduced to endless and futile debate and day-to-day reactive exchange rate and liquidity management to the exclusion of all else.

The irony is the solution to the problem is a problem itself. Both the sterilisation (MSS) bonds and the daily reverse repo themselves entail a payout of Rs 15,000-20,000 crore as interest, which comes out of printing money.

So measures to check excess liquidity and its spillover to prices are themselves inflationary! Truly the story of the dog trying to catch its own tail!

What then can be done? First, we should have some idea of the cost-benefit of unfettered capital flows into the economy. (In a recent thought-provoking article, Arvind Subramanian argues there is no proof that it does good). The Prime Minister’s Economic Advisory Council, headed by Dr C. Rangarajan, might like to ponder and research this question.

Second, we must move beyond simplistic thinking (‘let us just allow the currency to appreciate’).

Third, we should consider radical changes such as having a completely distinct class of shares for foreign investors. (Hint: Study the cases of foreign investment in two almost identical software companies, Infosys and Cognizant Technology, and their costs to and multiplier effects on the economy and one would get the point).

To regain control, the RBI might have to pray for some event – even negative – which will curtail foreign flows and restore its lost freedom in monetary policy.

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