In its effort to contain the Asian contagion from touching the shores of the subcontinent, the Reserve Bank of India has finally swung in action using its multi-edged brahmastra to stem destabilising speculation in the forex market and stabilise the rupee.The increase in the bank rate from 9 per cent to 11 per cent and raising the CRR pushed the cost of funds up in the short term money market and did the trick of pulling up the sliding rupee. When forex speculation becomes one-sided with majority of operators on the demand side, the central bank cannot work only on the supply side by providing the forex but has also to tighten the demand side by making the cost of credit higher.
The latter helps in curtailing the demand in the spot market as well as containing the premium on forward rates and thereby reversing the trend of one sided forex market. The rupee stabilisation following the RBI's measures has proven this market behaviour.While the rupee exchange rate has assumed top priority on the RBI's agendafollowing the Asian currency crisis, the RBI has also been assiduously using all the weapons in its armoury to revive the industrial economy for the last one year. In its seemingly final attempt to usher consumer demand, investment and industrial growth in, it cut the bank rate and CRR, rationalised SLR and freed deposit rates. One couldn't have asked for more.
The critical question was, will the unleashing of additional liquidity in the banking system and cut in the prime lending rate spur credit demand, generate higher investment growth and accelerate the wheels of industry. This brings us back to the Keynesian theory. To put it in former RBI governor S Venkitaramnan's remark `Will the horse drink water?' Will the economy respond to the monetary prescription? And how fast?.During the 90s the process of economic liberalisation has been accompanied by IMF formula of stricter budgetary discipline and minimal fiscal deficit. Going back from Keynesianism to Adam Smith's market mechanism to improve efficiencyof capital and achieve higher economic growth with lower inflation has not been painless process. Comparing the experience of many emerging market economies of eastern Europe, Africa and Latin America during his process which had to go through the phase of negative rates of growth, high inflation and unemployment would give us a sense of complacency.
India's approach of liberalisation in phases has succeeded in skipping the trauma of sudden opening up. Yet the phase our economy is caught today is the result of a mismatch in the economy. The IMFism which reversed the Keynesianism needed the target 3.5 per cent fiscal deficit to be achieved. This meant a cut in the government expenditure and investment in the infrastructural areas as well funding of capital outlays of several public sector enterprises. The public sector investment in India despite its average lower efficiency of capital has always been the prime mover of the industrial growth and the economy. So long as the capital market remained buoyantboth the public and private sectors could raise resources through the market directly from household and institutions and mutual funds until 1995.
Since then the structure of Indian stock market has changed and it has also witnessed a prolonged bear phase and paralysis of stock valuations. Investments until then through the capital market seemed to compensate the decline sin the budgetary support of public investment since the industrial growth was on an upswing. Unlike China and the Asian tigers India didn't depend on foreign investment to prop up its growth rate. Hence the capital market did a splendid job until 1995 to keep the investment rate high despite the decline in the public sector investment and government capital expenditure.
The phase of high interest rate but more than that the collapse of equity valuations finished the party. In 1991 too the economy passed through the worst forex crisis and tight liquidity situation raising interest to the record high level. What happened thereafter is wellknown. The Manmohanomics restored the forex balance, improved domestic liquidity, lowered interest rates and spurred investments under the buoyant stock market and the exuberant primary market. The Indian economy and the domestic industry never had it so good. The current economic situation marks a striking contrast to the conditions in 1991.
The forex situation is most favourable with forex reserves of $27 billion. The exchange rate is stable and fundamentally strong due to the underlying balance of payments support in the midst of all our neighbours suffering from heavy currency depreciation. And yet with the liquidity squeeze transforming into liquidity surfeit and lending rates reaching a record low, the industrial economy was not responding to the RBI's signals.(To be concluded)(The author is the CEO of Unit Trust of India Investment Advisory Services Ltd)
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
