CRR hike will not contain price rise

Dr Bharat Jhunjhunwala

Reserve Bank of India has increased the Cash Reserve Ratio by 0.25 percent on top of increase of 0.50 percent made earlier. Cash Reserve Ratio determines the amount of money commercial banks have to deposit with Reserve Bank in form of security. The idea is to suck out liquidity from the banking system and encourage commercial banks to lend fewer amounts. Commercial banks will have to deposit larger amounts with Reserve Banks and will have fewer funds available for lending. Less home- and car loans will be given leading to less demand for cement and steel. Businesses will set up fewer factories and stock fewer goods in absence of loans. This will lead to lesser demand for goods in the market and cool down the economy and help control price rise.

These measures are likely to reduce demand both for consumption- and production. Banks will give out fewer loans for purchase of cars leading to lesser demand for cars. At the same time, they will give fewer loans to automobile manufacturers leading to production of fewer cars. Fire cracker manufacturers of Sivakasi, for example, start producing crackers for Diwali many months early. They hypothecate the goods to the banks and avail of loans against stocks kept in their godowns. They will be able to accumulate fewer stocks and also the purchasers will buy fewer crackers due to paucity of loans. Thus balance will be reestablished in the economy between supply and demand at a lower level.

The Reserve Bank has left Repo and Reverse Repo rates unchanged. These are the rates at which Reserve Bank lends to commercial banks or at which commercial banks deposit excess monies with the Reserve Bank. These rates are generally for short term lending. Banks prefer to borrow from the public for their long term requirements at rates more favourable than offered by the Reserve Bank under the Repo window.

The two steps taken by the Reserve Bank give contradictory messages. By leaving Repo rates unchanged, the Reserve Bank has encouraged commercial banks not to increase the rate of lending. By increasing the Cash Reserve Ratio, the Reserve Bank is encouraging commercial banks to lend fewer amounts. But reduced liquidity will increase pressure upon commercial banks to increase their lending rates. It must be recognized that the Repo window is used by commercial banks to manage short term requirements of liquidity. It has less relevance for long term rates which are determined by supply and demand of credit. Reduced supply of credit due to increase in Cash Reserve Ratio will certainly put upward pressure on lending rates. Chiefs of many commercial banks have said that they will reconsider the lending rates in view of the changed stance of the Reserve Bank.

The Reserve Bank is not likely to succeed in controlling prices by these measures because these measures deal only with the domestic component of the economy. The main reason for increase in price at present is not domestic but international. It is reported that Foreign Direct Investment (FDI) in the first three months of 2008 has been at record level of about $10 billion. Indian companies have also borrowed in foreign currencies hugely known as External Commercial Borrowings (ECB). Part of this huge inflow is nullified by sell off to the tune of $3 billion by Foreign Institutional Investors in the share markets. But the overall flow remains inward and huge. This appears to be the main reason for increase in prices. Foreign Direct Investors and domestic companies are busy setting up new factories leading to increase in demand for men and materials.

The inflow of foreign money through FDI and ECB routes is increasing the pressure in the Indian economy much like filling the pressure cooker with much water does. The Reserve Bank has increased the Cash Reserve Ratio to partly neutralize the impact of these inflows. Think of the Indian economy as a pressure cooker with two taps. The Reserve Bank has closed the tap of domestic lending to make space for the monies coming in from FDI and ECB routes. This policy would have been successful if the inflows from FDI and ECB routes had remained at present rates. In that case less domestic lending by commercial banks would have lowered the total inflow into the pressure cooker and reduced the pressure. But raising the Cash Reserve Ratio and consequent upward pressure on lending rates is likely to lead to greater inflows of foreign capital.

Foreign banks are often involved in arbitrage. They borrow monies in countries with low rates of interest like Japan and lend the same in countries with high rates of interest like India. The interest rates in Japan, for example, are about 1-2 percent. Let us say foreign banks were lending in India at 10 percent at present. Now they will be able to lend at 11 percent. This will make it more attractive for them to borrow larger amounts in Japan and lend in India. The upward movement of bank lending rates in India will provide greater opportunities for arbitrage and lead to more foreign capital inflows. The Government is continually increasing the caps on limits by Foreign Direct Investors in various sectors. This will provide encouragement to higher inflow of FDI. Thus, the reduction in demand due to reduced domestic lending will, in my opinion, be more than nullified by increased inflow of foreign capital.

The Reserve Bank has expressed confidence that the increase in Cash reserve Ratio and unchanged Repo rates will help contain price rise and also maintain Indian economy at the high growth rate of 8 percent. My assessment is that growth rate will indeed be maintained as claimed by the Reserve Bank. Reduced lending by domestic banks will not hit the level of investment in the economy because this will be more than made up by increased inflows from the FDI and ECB route. But the price rise is not likely to be contained. Reduction in demand due to lesser domestic lending will be nullified by increase in demand from FDI and ECB routes. Thus we should expect continuation of the present scenario of high rates of price rise and growth rates.

These policies will affect players in different ways. Foreign Direct Investors and foreign banks engaged in arbitrage will stand to gain due to higher levels of activity. Large Indian corporate houses will also be affected only marginally. They have access to External Commercial Borrowings. They will compensate for reduced lending by domestic banks by borrowing more through the ECB route. The smaller Indian business will be hit most. They will have less access to bank lending and face the brunt of the present policies. In conclusion the Reserve Bank will not be successful in containing prices though present growth rates are likely to be sustained. These policies will impact domestic small businesses negatively while providing more free play to foreign players. A better policy would be to restrict FDI inflows and keep Cash reserve Ratio low.

Controlling 'Unruly' MPs

By Sondip Bhattacharya

The Lok Sabha Speaker, Mr. Somnath Chatterjee, is always in the news sometime for good reason and sometime for wrong reasons. Unlike his predecessors he is not a good crisis manager, and is prone to provocations from opposition benches in Lok Sabha. His ties with the opposition are already strained.

In an unprecedented move Mr. Chatterjee has cracked the whip by sending as many as 32 'unruly' MPs to the privileges committee. The action follows a series of warnings by the chair that he will initiate disciplinary actions against the MPs who have been often disrupting proceedings by trooping into the well of the House to indulge in sloganeering.

While 31 members have been referred to the scrutiny of the privileges committee for indulging in continuous sloganeering on April 24 over inflation and Mr. Baalu saga relating to subsidized gas supply to his sons' enterprises. Despite the chair pointing out that the very subject was discussed in the House just a few days ago, another one, Brajesh Pathak of BSP, faces the heat for repeatedly preventing Union Minister Ram Vilas Paswan from making a statement in the House the next day.

On both the occasions, the chair had repeatedly warned members to call off their disruptive tactics or face action while instructing the staff to note down their names. Of the 32 MPs, 22 belong to the BJP, four to the Shiromani Akali Dal, two BJD, one each from BSP and JD(S).

This could just be the beginning as there are indications that the Speaker is in the process of handing out similar orders to another group of obstructive MPs-some from the NDA (who held up House proceedings on April 28, over the T.R. Baalu issue, despite the Speaker saying he was willing to allow a discussion on the matter if proper notices was given), and a few from Samajwadi Party and BSP who indulged in sloganeering over price rise, Bundelkhand and Public Distribution System (PDS) issues respectively.

A Lok Sabha bulletin, dated April 30, and released on May 1 said: "The Speaker, in exercise of his powers under Rule 227 of the Rules of Procedure and Conduct of Business in Lok Sabha has referred the matter relating to disorderly conduct in the House by the following members to the Committee of Privileges for examination, investigation and report".

That rule empowers the Chair to refer the case of these members to the privileges committee under Rule 349 which says: Whilst, the House is sitting, a member shall not interrupt any members while speaking by disorderly expression or noises or in any other disorderly manner; shall maintain silence when not speaking in the House; shall not obstruct proceedings, or interrupt and shall avoid making running commentaries when another members is speaking; shall not shout slogans in the House."

A week ago, the Rajya Sabha witnessed such a rare incident when the Chairman ordered an obstructive AIADMK member to leave the House, which then led to the Opposition members registering their protest with Mr. Hamid Ansari, saying his action was too harsh.

In this case, there will be no immediate bar on these 32 members from attending the House proceedings but they will be served notices by the Lok Sabha privileges committee to summon them for hearing to examine whether their conduct amounted to the breach of privileges (of the other members to be heard while speaking by ensuring the orderly functioning of the House) and, finalise the punishment if found guilty.

The Lok Sabha secretariat pointed out that the chair has been making repeated appeals, both in the House and during the closed-door meetings with the floor leaders, to put an end to the practice of disrupting proceedings every now and then. While the Speaker has been telling many senior colleagues that while the members forcing the adjournments of the House 'in extraordinary situations' were quite understandable, same can't be justified as a routine.

During one of the meetings, the Speaker proposed the 'no work, no pay', norm which was rejected by almost all parties even while some of them opined that the chair could invoke disciplinary actions in extreme cases of unruly behaviour. He seems to have started that.

Among members who face the heat are seniors like Shahnawaz Hussain, P.S. Gadhavi, M.A. Kharabela Swain, Kishan Singh Sangwan and Kiran Maheswari of BJP, Chandrakant Khaire, Kalpana Ramesh Narhire of Shiv Sena, Rattan Singh Ajnala and Sukhdeo Singh Libra of Akali Dal and Tathagatha Satpathy of BJD.

It is necessary to give the background why MPs were agitated over Mr. T.R. Baalu's letters of request to Prime Minister Manmohan Singh, 'requesting' for gas supplies for his son's companies. The letters were forwarded to the Minister for Petroleum and Natural Gas Murli Deora. Mr. Baalu, of course, describes it as 'justice'. No matter how much they all protest, there seems to be everything unusual about the Baalu episode.

It is unusual, not merely because Mr. Baalu used his position as a minister in the Union Cabinet, but also because he was not willing to fork out as much as other commercial entities were required to pay for gas supplies.

Mr. Baalu wanted gas for two companies-King Chemicals and Kings High Power-run by his sons. The minister says that he arrived at an agreement with Gas Authority of India Limited (GAIL) in 1999 for 10,000 cubic metre of gas and 0.45 million cubic metre gas per day, respectively. He was right when he said that, but what Mr. Baalu chose not to tell Parliament during his "confession" was that he wanted gas at the administered price of $1.96 per million British thermal units (mBtu) when it was being sold at anywhere between $6 and $16 per mBtu in the market.

The UPA government will insist that there is 'nothing unusual' about it. Mr. Baalu, of course, describes it as 'justice'. Remember what he told Parliament? "Thousands of shareholders approached me and said, 'the company has got sick. Now you are at the helm of affairs, you are minister. Why don't you put our case before the petroleum minister so as to have justice," Mr. Baalu told the Rajya Sabha last week.

But the speaker's decision to virtually single out the opposition-Left MPs have also been raucous in raising the demand for higher PDS allocations for West Bengal and Kerala-might trigger a controversy. BJP spokesperson and RS MP Prakash Javdekar said the government has to be responsive for the smooth functioning of Parliament. Allies and supporters of the government themselves disrupt the functioning of the two Houses, he said.

During the NDA rule the Congress party and the Left held many times both the Houses to ransom, and no business was transacted for 98 days in total due to sloganeering of the then opposition parties. And Mr. Somnath Chatterjee was in the forefront to block the proceeding of the Lok Sabha. Our politicians have short memories about what they did in the past.

If the privileges committee decides to expel the MPs named by the Speaker, to be sure the judiciary will be the final arbiter, once again leading to conflict between the two pillars of democracy.

While the opposition does stall Parliament, a part of the problem seems to be poor communication with the government. Usually, when the House is stalled, there is an effort to resolve issues through discussions led by the parliamentary affairs minister and Speaker. During the UPA government's tenure the opposition and the ruling combination have been on collision course, which is not a healthy sign for democracy. Punitive action by the Speaker will further embitter relations between the rulers and the opposition. INAV