The RBI’s misplaced aggression will hurt us

By not raising signal interest rates, the central bank has sent the wrong message to everyone

Psychology has a term for it: displaced aggression. It works like this. Your boss sends you a stinker, but since you cannot tell him what you think of him, you take it out on your spouse. The spouse, if he happens to be a docile type, will work out his anger on the kid or the domestic help, who, in turn, will throw a stone at a passing street dog. Your anger with your boss finally plays out on the dog.

Your aggression finds the wrong target, and hence is “displaced” or misplaced.

Displaced aggression is the hallmark of Duvvuri Subbarao’s latest monetary policy. His boss, the finance minister, does not want interest rates raised for political reasons, and his ministry bureaucrats have been throwing dark hints about it. But the Reserve Bank governor cannot tell them where to get off, for he has to keep them in good humour, whatever be their dubious credentials as economists.

He knows that between the finance minister and the UPA’s spendthrift ministers they are completely busting the Budget, but he can only send coded messages in Swahili to them in the hope that they will finally get it.

But anger at one’s own impotence has to be worked off, and Subbarao’s thunderbolt landed on banks — who have no ability to hit back at him. For here, he’s the boss.  To send a signal that inflation is roaring back and money is too easy, the governor raised the cash reserve ratio (CRR) for banks by 0.75%, forcing them to gift the Reserve Bank their hard-raised cash for free. CRR balances maintained with the central bank earn no interest, and at one stroke, the governor has created Rs 36,000 crore of NPAs — non-performing assets — for the banking system.

Left with banks, the money would have at least earned some interest by being lent in the inter-bank market. Some of it would have been parked with the central bank, and a little would also have been lent to needy companies. But by immobilising it, the RBI has rendered the money useless to everybody. Banks lose out: they pay interest on your deposits, but the RBI confiscates it and pays nothing.

Banks, of course, are not going to take it lying down:  despite the fact that they have huge resources to lend, they will not do so. They will continue to mollycoddle the big stars of India Inc and charge usurious rates from small and medium companies who have no option but to pay. Small and medium companies are the economy’s growth engines; they create the jobs and spending power, not the biggies.

But they get fleeced because the RBI wants to send a signal to the finance ministry that it is spending too much, and inflation is getting out of control.

Given that the RBI has raised the March-end inflation target to 8.5%, the only signal it needed to send was on interest rates. It needed to raise the repo rate — the rate at which the RBI lends to banks — to tell everyone that it is serious about fighting inflation.

To be sure, banks are not going to borrow in the immediate future, since they have idle cash in sackfuls, but the message would have gone home. It is serious about inflation.

The other reason to raise rates is confidence. When you tell the world rates need to rise, it is a bullish signal. You are saying the economy can handle higher rates without shrivelling. Not only that.

Bank depositors are now earning negative real rates. Calculate how much you lose when your fixed deposit gets you 6.5% and inflation is chewing up your rupee’s value at the annual rate of 7.3% and heading for 8-10%. This is the way banks are getting their revenge on the RBI. They are telling the RBI: sure, go ahead and crimp my money with CRR, I will fleece the depositor and non-blue chip borrowers.

By not sending a rate hike signal the RBI is, in fact, fuelling asset price inflation — again driven by politicians who like booming stocks and booming realty. A booming stock market gives everyone the illusion that all’s fine with the world; a booming property market combined with low home loan rates keeps home prices up and the home buyer’s long-term debt profile high. It’s not in your interest to borrow cheap and pay for costly houses. You should be paying less for the home and more for your loan.

But politicians don’t want it that way.

They are in cahoots with builders and criminal elements to keep a lot of their ill-gotten wealth in property, and this is why they like low rates and high property prices. Their net wealth depends on it. By not raising rates, the RBI is willy-nilly aiding the politicians in their nefarious purposes.

Mr Subbarao, this is surely not the best policy you could have produced.