Keep the money moving

Indian Express, 17 November 2008

The RBI has announced yet another set of much needed measures to boost liquidity and open up channels for credit flow. RBI's steps on improving liquidity in recent weeks consitute what has been perhaps the fastest response from Indian policy makers seen in recent years. Yet, as the situation unfolds, these may not be sufficient to help the economy adequately in coming months. There are some issues that need urgent attention.

1. Lower cost of credit. RBI has done well in improving rupee liquidity and dollar liquidity. All levers should be applied to ensuring that the local money market works well. Firms should feel confident that they are able to borrow large quantities of money at prevailing interest rates. Fears about a potential shortage of dollars should be forestalled well ahead of time. Capital controls should continue to be eased to allow firms to access dollars wherever available. Line of credit should be established with the US Fed, EXIM banks and multilateral agencies. Once call money rates stay stable and confidence in liquidity availablitiy is restored, the RBI should cut both the repo and the reverse repo rates in line with slower growth and lower inflation expected in coming months. The RBI should not only be ahead of the curve, it should also be seen to be so.

2. More transparency on reserves. RBI intervention and revaluation data should be published weekly along with the data for value for reserves. When the US dollar Euro or yen rate changes it leads to changes in the value of India's reserves that are held in both USD and Euros and yen, or revaluation. When the weeky data for reserves is published there is a huge amount of guess work going on about the how much is RBI intervention and how much is revaluation. If the market does not know what part of the decline in reserves is due to revaluation, there is a perception that all of it is due to RBI intervention. This leads to two fears (a) that RBI is sucking rupees out of the market and soon liquidity will tighten again, and so banks cannot reduce lending rates, and (b) that if reserves continue to decline at the rate of USD 10-15 billion a week then in less than six months we could be down to zero. Publishing weekly data on revaluation and intervention will reduce misperceptions about RBI actions.

3. Open credit channels. For the problem of ensuring that the money market i.e. the market for short-dated bonds, works well, or for the problem of enabling PPP infrastructure projects, a critical bottleneck is a properly functioning bond market. The path to make the bond market come about has been mapped out by the Patil, Mistry, and Rajan reports. This requires implementation within weeks and not months. The problems that we have seen with mutual funds, the money market, NBFCs and real estate companies are closely related to issues of financial sector regulation. When external shocks were juxtaposed with the segmentation in Indian finance, this led to an acute crisis. In coming months, all firms, small and large, are going to face adverse shocks. A well functioning financial sector is critically required, for providing the better firms with equity, debt and financial engineering through which they can ride through the crisis. It is important to remove the regulatory hurdles that prevent credit from flowing smoothly.

4. Limited scope and capacity for fiscal expansion. Chinese-style plans for vast infrastructure expenditure are inappropriate for India. The fiscal space is lacking, and there are multi-year delays from thought to execution. However, increasing infrastructure expenditure is feasible and desirable for ongoing projects. In areas like the NHDP or the Bombay-Delhi freight corridor, where mature institutional structures exist, existing expenditure programs can be accelerated. Policy makers need to work on ensuring that these programs work well in the sense of (a) using money efficiently and (b) increasing the pace at which projects are executed.

5. Improve bankruptly code. In a downturn, some firms will die. While these are unpleasant events, interfering with the processes of firm death may not only be beyond the capacity of the government, it will not be desirable. The focus of government should be on dealing with the consequences of firm death rather than on trying to prevent them. We have seen in the past that sick mills that were taken over by the goverment in periods of distress never recovered and remained a liability for decades. The bankruptcy code recommended by the Rajan committee should be put in place. Banks and creditors should be able to recover dues rapidly and not be stuck in courts for endless years.

6. Monitor banks continously. One clear area that requires focus is the transmission of firm failure into bank fragility. A special push is required on monitoring weak banks and rapidly addressing them. Banking supervisors can miss out crucial weaknesses in banks when the supervision takes place at long intervals. In a rapidly changing environment supervisors needs to work overtime.

7. Ensure NREG works efficiently. When layoffs take place, labour market conditions will become soft. Even though NREG is limited to rural India, and setting up an urban NREG in a hurry may not be feasible, since a large section of workers are migrant and contintue to have rural links the NREG is now particularly important. It can both help individuals who are experiencing bad times and generate counter-cyclical expenditures. At the same time, new work should be initiated on improving the efficiency of implementation of NREG. The government should make sure that there is a timely release of adequate funds for the program.

8. Government should not interfere with market prices. Companies in distress will lobby for government support. Big companies will lobby more effectively than small companies. It is particularly important for government to stay focused on systemic issues, and not implement policies that help one group but could hurt another. The pricing of commodities eg. steel which are finished products for some but raw materials for others, should not be interfered with either through tariffs or other means. Government interference would normally lead to policies in favour of large vocal firms and against small and more numerous companies.

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