It is a sign of the depth and quality of our economics-literate section of chattering classes that we are still debating the finer points of monetary policy while standing fairly close to a potentially sharp drop in economic activity. Two of these finer points need to be addressed. First, the criticism that ministerial involvement in monetary and banking policy is compromising institutional quality. RBI’s policy independence, it’s been alleged, has been circumscribed by government instructions and via appointments of economists in government who disagree with RBI. The short answer is that RBI’s internal assessments have been deemed to be insufficient on what a crisis is and the government’s actions have been informed by crisis-management imperatives. In a game-changing crisis, the playbook has to be set aside sometimes. As for public sector banks (PSBs) taking the advice of the finance minister on cutting interest rates, let’s agree that this is hardly the first time the owner has told PSBs what to do. Also, PSBs enjoy a big spread, larger than that enjoyed by private banks. Plus, ministerial prods on rate cuts are not inconsistent with careful scrutiny of PSBs’ balance sheets; different PSBs will have different abilities on rate cuts. Ideally, no one would want ministers or prime ministers prodding banks or the central banks. But we don’t have an ideal situation. When we are back to normal times, we can only demand fully uncompromised RBI and bank operational freedom, we can also advocate RBI reform and diluting government equity in PSBs.
The second criticism is that calls for lower interest rates are illogical because, first, credit is growing quickly and, second, lower interest rates conflict with other policy objectives. Credit is growing at a healthy pace—a little less than 30%—because banks have been financing oil/fertiliser company deficits as well as taking care of big corporates’ additional needs; the latter is finding external financing tough. Surprisingly, no one’s talking about small & medium enterprises, the bulk of India’s industry. SMEs are getting shut out in the credit game. The good argument is that signalling lending rate cuts needs to be stronger—a further repo cut and a cut in reverse repo as well, the latter so that banks have less incentive to park money with RBI. On the issue of lower interest rates and fewer incentives for foreign inflows like those from NRIs, the comparison should be between off-shore rates and in India’s. Even after cuts, Indian rates will be competitive. The key thing to recognise is that trying to boost economic activity once a slowdown has taken deep hold will be difficult. The time to act is now. In fact, right now there’s probably a case for overcompensation on liquidity, credit and even lower lending rates.