Thus far, no further

To address the risk of a few segments, the larger risks in the economy are being overlooked

Between the last time the RBI assessed the economy and now there are two significant changes: First, of course, is the overall liquidity conditions - it is much tighter now. Second is credit growth, which continues to be high and the gap between credit and deposit growth is increasing by the day.

To a large extent, the RBI can take credit for tightening of market liquidity. Yet, it has not succeeded in reining in credit growth, especially to the overheated retail credit markets. Given that, the RBI had set out to reduce the latter, it has so far achieved the secondary objective and not the primary one.

The primary objective of the regulator has been to create a situation where more liquidity will not flow to those segments of the financial and non-financial markets that have been soaking it in over the past one year now; be it the equity markets or the real estate market or the personal credit segment.

Any generic solution like a stand-alone hike in the interest rates will have no major impact on credit growth to the overheated segments. If anything, it will compound the specific problem in the debt markets in absolute as well as relative terms. Hence the need for a combination of measures which RBI has been doing.

RBI has done well to raise the repo but leave the reverse repo rate unchanged. The repo rate hike has got subsumed into the effects of the S&P ratings upgrade, which seems to have come at a perfect time, at least for RBI, to push a rate hike through with minimal disturbance. The expectations of more liquidity infusion are real and this has a salutary impact on expectations.

Also, in a relatively illiquid market, the reverse repo rate becomes the signalling rate. Having factored in a rate at both ends and a spread of 175 bps, having a corridor of 150 bps has been well received by the debt markets and hence the rally, post the announcement.

The most critical issue is that with the current bout, the season for hikes seems to be over. At least one hopes it is. Though RBI does not indicate it directly, the threat of another hike is conspicuous by its absence in the statement which talks of using CRR and other levers of liquidity control for monetary management.

The end to hikes is warranted now because from here on, what the system requires is not a directional change - from high liquidity to tighter liquidity or from pricing of credit, from less expensive credit to more expensive credit more expensive.

Instead the need to ensure allocative changes in credit. This can be achieved only through sectoral measures which are unlikely to impair macro-economic growth, but can change the composition of credit.

Here the RBI has once again gone for increased risk weightage and provisioning in real estate, capital markets and credit
cards. The danger is that, RBI is virtually going back to a system of directed lending. This, as a matter of principle and policy, is not desirable. If this continues any further, it may well begin to backfire.

While, there is no dispute on the issue of provisioning, there have to be better ways to address the sectoral deployment. Banks must have flexibility and should not be led to lend. Given the regulator’s long standing concern on real estate, one option could be to work out a system whereby the real estate portfolio of banks is marked to the market.

Such a system will give banks freedom and also be much more prudential than ad hic increases the risk weightages. This makes a mockery of the existing prudential and bank’s own risk assessment and systems.

It is also an issue worth considering as to how the banks will individually address the growth of retail credit. The fact is that, on the liability side most banks can and do contract liabilities only of a short-term nature. It is in the interests of asset liability management that they do raise their retail portfolios. The moment they start doing that in tandem, the retail market is seen as overheated.

If they don’t increase their retail portfolio and go in for financing longer term products, banks will get into serious asset liability mismatches. So, it is a choice between the devil and the deep sea for individual banks. And it is only the overall banking system, indeed the financial system, that can collective address the issue. In that the lead has to be taken by the RBI.

It is not enough for the RBI to point out the impending problems of low deposit growth and high advances growth. Quite apart from being an individual bank’s problem — easily resolved by taking recourse to high cost borrowings and compromising on margins — it is a systemic issue at two levels.

First is the macro-economic imbalance of debt-equity ratio for the economy which can have serious consequences. Although there is some flexibility in the composition of debt-equity in financing corporate growth, too much variation in it is not desirable from the point of view of both the lenders and the borrower.

If the financial sector is unable to provide funds in more or less the same proportion as required by norms, the investing
entities could meet their funds need in whatever form they are available; and thereby expose them selves to needless risk.

As a consequence, the over-all risk profile of the economy would go up. The bottom line seems to be that in its desire to address the risk of a few segments in the financial markets, the larger risks in the economy are being overlooked.

Losing way
Rather than a directional change, there is a need to ensure allocative changes in credit.

It is not enough for the RBI to point out the impending problems of low deposit growth and high advances growth.

While, there is no dispute on the issue of provisioning, there have to be better ways to address the sectoral deployment.

The writer is chairman,
Jammu & Kashmir Bank