Column

The latest tinkering with the credit and monetary policy is on expected lines. But, what should raise eyebrows is the rediscovery by the Reserve Bank of India of the cash reserve ratio as a powerful weapon to suck out the excess liquidity in the system - rediscovery because, first, only around a year ago, the Reserve Bank of India Act of 1934 was amended to dilute - in fact, even technically to do away with - the role of the cash reserve ratio from our banking system and, second, this tool was not resorted to at all during 2005-06 and till the fag end of the third quarter of 2006-07.

But, all this changed in late December last when the CRR was hiked to 5.25%. Since then, there have been as many as seven hikes in the ratio over a period of just four months and another one will take effect on August 4 when the CRR will be pegged at 7% as compared to 5.25% on December 23, 2006 and 4.50% on June 14, 2003.

The rationale behind this move is easy to understand. A higher CRR impacts on the money multiplier and thus acts as a break on the ability of banks to expand their credit portfolio. Since the system is awash with funds, the impounding of a portion of bank deposits makes eminent sense as this will leave enough lendable resources to meet genuine credit needs.

So, the economy is slated to continue on its high growth trajectory in the current fiscal as well despite the new twist in the stance of the monetary policy. RBI itself sounds upbeat on this score with its projected 8.5% surge in real GDP.

But, what should engage us is a wholly different issue — the attempt to dethrone CRR -and the hasty retreat from it — over a span of less than a year. It was only in June 2006 that an amendment to the Reserve Bank of India Act of 1934 was enacted by Parliament. In particular, an amendment to sub-section 42(1) of this Act empowered the RBI to prescribe CRR without any ceiling or floor which, prior to this change, could range from 3% to 20%.

Even the payment of interest on eligible cash balances was done away with pursuant to this amendment so that RBI was not obliged to pay any interest under the new dispensation. A zero CRR stipulation came within the realm of possibility with the passage of this amendment as also - though it is improbable, a CRR exceeding 20%.

However, when the gazette notification followed on January 9, 2007, there was a surprise. All the amended provisions were given effect to, except Section 3. This section provided for the removal of the floor and ceiling in regard to CRR and also to the payment of interest on eligible CRR balances. This means, that since Section 3 is not notified, status quo ante continues to be valid and the range of 3% to 20% in the fixation of CRR holds good.

The repeated hikes in CRR suggest how vital this instrument in the conduct of monetary policy. Though an indirect tool, it is nonetheless effective and convenient. The latest monetary policy stance also indicates how firmly it is entrenched in the system and the amended RBI Act is only an enabling provision.

This is as it should be. This is because the resort to CRR in influencing and fine tuning monetary policy is secondary - though important - to its more basic role as a prudential measure. Banks deal with public money and the stipulation of a CRR is a comforting factor in that it enjoins the banking system to keep a stipulated sum in a liquid form and bars it from a reckless credit-creation spree.