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Opinion: Mridul Saggar:

Amid high inflation and exchange rate pressures, rate hikes and tight liquidity are the best bet.

The RBI has been broadly getting its act right amid difficult circumstances. In my assessment, it has traversed about three-fourths of the amplitude of the current rate hiking cycle, but the economy is stronger than before.

It belies the misconception that if RBI starts hiking rates, the nascent recovery from the pandemic would be nipped in the bud. The RBI has demonstrated its ability to act on both sides of the business cycle. It may have been trifle slow to start normalising but has almost made up for that.

After completing my term at the MPC, I had publicly stated that the terminal rate in this tightening cycle could be 6.5 per cent, though RBI could turn data dependent after raising policy rate to 6.0 per cent. The cycle is broadly evolving along those lines. It is heartening to see RBI shed its panache for forward guidance that was constraining policy flexibility. Even so, the third successive 50 bps rate hike at end-September after an initial 40 bps did not surprise or disrupt the market.

Forward guidance may have served a useful role in the early period of the pandemic but has long over-lived its utility. If RBI had in this end-September policy gone on to hint anything on terminal (maximum) policy rate in this cycle or the time till which it would continue to hike rates, it would have only tied itself in knots at the time when global uncertainty is extremely high, and agility of response is needed to maintain macro- financial stability.

Rate hike appropriate

In my view, the MPC has got the rate hike quantum right. Turning to smaller rate hikes would have been premature at this stage and would have misguided markets besides adversely impacting central bank credibility. The economy is rather strong and inflation is still well above the target.

The RBI has more work to do to do bring down inflation within the target range to soft- land the economy first and then move it very close to the point target of 4 per cent in a two-year period so that gains from inflation targeting in anchoring expectations are not lost and higher growth over medium-to long-run is realised on the back of a stable environment.

The one dissent in the MPC on the quantum of rate hike is, therefore, not very material. While one does anticipate some slowing down of the economy ahead, four things need to be kept in consideration.

First, the RBI has some catch-up move left as real deposit rates are still negative and can further feed into widening current account deficit (CAD) that is mirrored by saving- investment gap. Unless the economy slows down markedly in coming quarters, the CAD/GDP ratio is likely to be about 3.4 per cent this year, perceptibly higher than indications of below 3.0 per cent CAD from the central bank. The central bank may be talking of bringing down the currency pressures, but even at 3.0 per cent the CAD is not sustainable and, therefore, the rate hikes are helpful.

Second, the RBI need not match the Fed’s rate hike quantum 1:1 as inflation is a bigger problem in the US vis-a-vis the inflation target. Yet, if the RBI holds rates at this level, it could entrench high inflation.

Third, a hesitation to raise rates would contribute to financial fragilities with asset mispricing. Fourth, it is important to understand that monetary policy can’t work without any growth sacrifice, even though from a political economy perspective, central banks find it hard to state this in their communication.

The quantum of the end-September rate hike can go a long way in delivering the goal to disinflate the economy — as monetary transmission gains traction with the large rate hike occurring for the first time after the system has moved away from large liquidity surpluses.

Banks have been unduly reluctant to lift deposit rates while pass-through has been more on the lending side mainly because of the large surplus liquidity. Their net interest margins have been protected at the expense of savers. Against a 140 bps rate hikes since May this year before the latest hike, the weighted average lending rate against the outstanding rupee loans rose by 41 bps, while the weighted average term deposit rates on outstanding domestic rupee deposits increased by just 26 bps.

Considering the RBI’s projected average inflation rate of 6.7 per cent, the weighted average real rate on the lending side works out to 2.43 per cent (1.63 per cent for fresh rupee loans which has risen by 82 bps in this hiking cycle), while that on the deposit side remains at (-)1.41per cent (see chart).

Liquidity management

While the RBI in its post policy communication sought to talk down the liquidity fears by explaining that liquidity is not too tight, the fact is that sans government balances system liquidity that sets the money market rates is temporarily in balance. Yet, durable liquidity surplus that includes government cash balance was ₹3.69 lakh crore on the eve of the latest policy.

Once festival currency leakages and more foreign exchange interventions take place, the durable system liquidity could tighten further and may hover at less than ₹1 lakh crore. Should the central bank worry too much about these tighter liquidity levels? Why should it when, in fact, it will force banks to raise deposit rates and accelerate transmission to positive real rates at which monetary policy can be deemed neutral and not yet tight in a true sense?

At a time when we face double whammy of high inflation and spillovers of exchange rate pressures, even marginally deficit liquidity conditions will be justified as it will ameliorate both these pressures.

Will this cause a destabilising interest rate spike? Not unless the government walks off the fiscal consolidation path as electoral cycle considerations come to fore. The government has so far done well to exercise restraint even while taking supply-side measures to reduce inflationary pressures.

(to be concluded)

The author is IEPF Chair Professor at NCAER. He was formerly RBI’s Executive Director and an MPC member. Views are personal.

Dominance of banking by PSBs has also been a hurdle in the way of improving the regulatory regime, which, in turn, hampers the modernisation and, therefore, healthy growth of the sector. This is because RBI has limited regulatory jurisdiction over PSBs. Indeed, this fact has at times provided RBI an easy cover for its own flaws.

Our July 2022 paper, ‘Privatisation of Public Sector Banks in India: Why, How and How Far?’, presented at the India Policy Forum of the National Council of Applied Economic Research (NCAER), has led to a lively debate on the subject. We appreciate the subsequent advocacy of public sector bank (PSB) privatisation by others such as the former Reserve Bank of India (RBI) governor Duvvuri Subbarao as well as constructive commentary from experts holding a differing view.

But we cannot help noting that the majority among the critics relied on the usual tactic of asking rhetorical questions such as:

Can private banks deliver on social objectives?

Haven’t there been big frauds in the private banks too?

Did India not escape a major fallout from the global financial crisis due to the robustness of PSBs?

Private Banking

Such whataboutery amounts to nothing more than obfuscating the bottom-line issue: when all costs and benefits are considered, is the balance in favour of maintaining the status quo, or privatisation of some or all PSBs? Policies may have some downsides. And, yet, we should adopt them whenever the upside unambiguously outweighs the downside.

In assessing the benefits of PSB privatisation, the first point to recognise is the criticality of a well-functioning banking sector for sustained rapid growth in a developing country. Banks must perform the function of mobilising the savings of savers and allocating them to the most productive investment projects. Failures at either end – mobilisation and allocation – can cost the economy heavily in terms of growth forgone.

Today, with GDP at $3 trillion, even the loss of one-percentage-point growth due to a poorly functioning banking sector would amount to losing $30 billion or more in extra GDP every year. The difference between growing at 7% versus 8% is a GDP of $5.9 trillion versus $6.5 trillion in 10 years’ time. The extra income from 1% additional growth each year can give the government far more resources to pursue social goals than any potential shortfall arising out of its ownership of fewer than the current 12 PSBs.

Evidence points to PSBs as having done a significantly poorer job than private banks when it comes to mobilising as well as allocating the savings to productive investments. On the mobilisation front, they have rapidly lost the share in total deposits to private banks. On the allocation front, they have accounted for disproportionately large share of loans that had to be written off in recent years. These non-performing loans (NPLs) cost the economy dearly in terms of growth, not only because the investments failed to translate into output but also because credit growth by the poorly performing banks came to a near standstill.

On top of that, the taxpayer had to foot the bill for the rescue of the banks. GoI had to spend a massive $57.45 billion to recapitalise the PSBs between 2010-11 and 2020-21. Each of the 12 PSBs required a significant sum out of these recapitalisation funds. Market valuations of some of these PSBs remain below the amount of taxpayer funds infused into them.

In comparison, among private banks, only Yes Bank required a rescue. And even that was accomplished without using taxpayer money. Moreover, its market valuation quickly rose above the value of resources devoted to the rescue. Also notable is the fact that during the NPL crisis of the last decade, credit by private banks continued to grow at a rate significantly higher than that by PSBs.

Holding to Account

Dominance of banking by PSBs has also been a hurdle in the way of improving the regulatory regime, which, in turn, hampers the modernisation and, therefore, healthy growth of the sector. This is because RBI has limited regulatory jurisdiction over PSBs. Indeed, this fact has at times provided RBI an easy cover for its own flaws in regulating the banking sector as a whole.

GoI is not only the owner of PSBs but also their policymaker and regulator. This is contrary to the principles of good governance. The staff of these banks remains subject to oversight by vigilance agencies that seriously undermines their ability to take even normal risk in lending. With salaries of senior staff capped by government rules, PSBs remain handicapped in hiring high-calibre managers and technical staff. At the same time, near-iron-clad job guarantee has resulted in resistance to productivity-enhancing change at all levels.

Any benefits of PSBs must be evaluated against these costs. It must also be asked whether the delivery of those benefits requires as many as 12 PSBs. For example, private banks have been as effective at delivering on priority-sector lending as PSBs over the last four decades. Even if there are goals on which PSBs can potentially deliver more effectively, one must evaluate the benefits of achieving those goals against costs.

We must also ask whether such goals cannot be achieved by retaining just one or two banks in the public sector. Will the nation not be better served if the government owned one or two banks and managed them effectively, instead of shelling out crores of taxpayer money every 5-10 years on keeping several of them afloat, and undermining the modernisation of the banking sector?

IEPF Chair Professor Dr Mridul Saggar speaks to Latha Venkatesh, CNBC TV18 on “RBI’s Monetary Policy Announcement in the CNBC Indianomics program, 30 September 2022. Watch the Video

Immersion of idols laced with harmful chemicals does an irreparable damage to a river, time to stop sinning against salvator.

It is that time of the year again, when the devout prepare fancy and exotic idols of gods and goddesses, venerate them for a few days and then consign them to the waters of our rivers. The immersion ritual, as witnessed during the recently concluded Ganesh festival and also anticipated during the forthcoming Durga Puja celebrations, has been a regular annual feature of the festival season across the nation. This is because our rivers are perceived as divine, almost supernatural, entities that have the power of salvation and exculpation of human sins. But while immersing idols signifies a sort of religious atonement for the ‘sinners’, unfortunately, the rivers that function as the sites for this redemption become the ones ‘sinned against’; for this paradoxical coalescence of divinity and desecration not only leads to surface pollution in the rivers but also damages their biodiversity and causes extensive and often irreversible contamination of the groundwater. Several of the idols immersed in the rivers are made from Plaster of Paris, which takes countless years to dissolve, and paint comprising heavy metals like mercury, cadmium, and lead.

River pollution is, in fact, a persistent area of concern across the country. Other research documents the high level of pollution and contamination in the Ganga river, which increases notably during the Hindu festive season. A study by the National Council of Applied Economic Research (NCAER) examines the state of Ganga river water quality at selected stretches of the river in recent years. For ensuring a detailed analysis of the polluting constituents in the Ganga, the NCAER team moved beyond conventional laboratory examination of water samples and used in-situ mobile sensor platforms equipped with GPS capability to pinpoint the pollution sources and hotspots in the river, and capture water quality data at high geospatial resolution. Noting a significant deterioration in the river water quality due to pollutants, the NCAER study points out that despite being among the top ten water-rich countries of the world, and home to both perennial and non-perennial rivers, India has become a water-stressed region.

Albeit, a large proportion of the pollution in rivers is the result of anthropogenic activities and the release of raw sewage, untreated industrial effluents, pesticides, and debris into the river. However, this does not diminish the polluting impact of visarjan or submergence into the river of idols made with non-biodegradable and toxic materials. So, wherein lies the solution? While seeking to purify ourselves through religious rituals, how can we ensure the purification of our rivers too?

For the last few years, the Central Pollution Control Board has been issuing advisories to prevent riverine pollution by prohibiting the immersion of idols, puja material, and religious offerings in rivers . Recently, the Delhi Pollution Control Committee (DPCC) too urged all urban local bodies in the city to set up temporary ponds in residential areas for the immersion of idols. The DPCC’s guidelines mandate the removal of worship materials like flowers and paper decorations, and of collection of biodegradable material used in the idols for recycling and composting, before the immersion.

However, while the advisory is clear on the ‘do’s’ and ‘don’ts’ about idol immersion, it is silent regarding the enforcers who would ensure diligent implementatio. What is the guarantee that the harmful chemicals released from the idols after immersion would not percolate underground through the multiple water bodies earmarked for the immersion? The larger, more serious implications of this could be contamination of the  groundwater. Further, decentralisation of idol immersion away from the Yamuna necessitates the redoubling of efforts to monitor the ground pollution level.

It is thus imperative for the authorities to follow a somewhat centralised approach for monitoring the pollutant load arising due to immersion. Both the authorities in Delhi and the Namami Ganga Clean-up Campaign being undertaken to cleanse the Ganga river can also draw lessons from the Kolkata Municipal Corporation which has been following the ‘no pollution’ principle during the Durga Puja rituals in Kolkata, wherein vats are placed alongside rivers for collection of decorative items removed from idols before their immersion. Thereafter, any residual debris in the rivers is extracted with the help of cranes to minimise the pollutant load in the river. This approach is certainly worth emulating.

The NCAER study also revealed that a large section of the people living in the Ganga river basin depends on the river for their daily needs and livelihood. Similarly, the Yamuna river is the aquatic lifeline for Delhi and its surrounding areas. Hence, even as the Yamuna, Ganga, and all our holy rivers ostensibly absolve us of our moral sins, the least we can do in return is to keep them free of physical and human waste.

Sanjib Pohit is Professor and Anupma Mehta is Editor at the National Council of Applied Economic Research (NCAER). The views expressed are personal.