Not the right time to abol­ish CRR

The Pak Banker - - Front Page - S. S Tara­pore

IN the re­cent pe­riod, there have been de­mands by banks for pay­ment of in­ter­est on cash re­serve ra­tio (CRR) balances. Al­though many an­a­lysts have ex­plained that from the point of ef­fi­cient mone­tary con­trol, in­ter­est should not be paid on CRR balances, the con­tro­versy has not died down.

As per law, in­ter­est can­not be paid on CRR balances, as CRR is a pow­er­ful in­stru­ment of mone­tary con­trol and pay­ment of in­ter­est on these balances at­ten­u­ates mone­tary con­trol. This was also ex­plained in this writer’s ar­ti­cle (Busi­ness Line, Au­gust 24).

State Bank of In­dia (SBI) Chair­man Pratip Chaud­huri, with the ex­plicit sup­port of the Gov­ern­ment, has been em­bold­ened to re­it­er­ate his de­mand that in­ter­est at 7 per cent be paid on CRR balances, and that if in­ter­est is not paid CRR should be abol­ished.

With un­bri­dled fis­cal deficits since the 1980s, the RBI, in­eluctably, had to raise the CRR to the then statu­tory ceil­ing of 15 per cent. As in­ter­est was be­ing paid at 10.5 per cent on CRR balances, it was al­most equal to the in­cre­men­tal amount of CRR balances im­pounded in a year, and as such the CRR, as an in­stru­ment of mone­tary con­trol, was to­tally eroded. As the fis­cal deficits mounted, in 1989, the law was al­tered, rais­ing the statu­tory ceil­ing to 20 per cent.

Dur­ing the cri­sis of 1991, the ef­fec­tive CRR was as high as 16.5 per cent. In an en­deav­our to re­gain mone­tary con­trol, in 1990, in­ter­est on cash balances re­lat­ing to the pe­riod up to March 1990 was paid at 10.5 per cent in­ter­est, but on in­cre­men­tal cash balances there­after, the in­ter­est was re­duced to 8 per cent and even­tu­ally brought down to zero.

As a re­sult, the ef­fec­tive in­ter­est rate on CRR balances fell to 4 per cent. Even­tu­ally, in 2007, in­ter­est on CRR balances was abol­ished by law. With the abo­li­tion of in­ter­est on CRR balances, the RBI has been able to bring down the CRR pre­scrip­tion to as low as 4.25 per cent.

The choice is be­tween a high CRR pre­scrip­tion with in­ter­est, or a low CRR pre­scrip­tion with­out any in­ter­est. Ob­vi­ously, a low CRR pre­scrip­tion with­out in­ter­est is prefer­able to a high CRR pre­scrip­tion with in­ter­est. This is some­thing that both the SBI Chair­man and the Gov­ern­ment need to un­der­stand.

The ba­sic pre­con­di­tion for abol­ish­ing the CRR is to bring down the fis­cal deficit way be­low what the lat­est fis­cal con­sol­i­da­tion roadmap in­di­cates. The Gov­ern­ment should be gen­uinely will­ing to pay higher rates of in­ter­est on gov­ern­ment bor­row­ing. But the ground re­al­ity is that, at present, the gov­ern­ment wants to bor­row more at lower rates of in­ter­est.

The CRR pre­scrip­tion can be abol­ished only when there is an ef­fec­tive in­ter­est rate trans­mis­sion mech­a­nism. At present, a para­mount ob­jec­tive of gov­ern­ment pol­icy is an ob­ses­sion with low in­ter­est rates in the econ­omy, de­spite high rates of in­fla­tion. In such a mi­lieu, the pol­icy in­ter­est rate can­not be the sole in­stru­ment of mone­tary con­trol.

The Gov­ern­ment, in des­per­a­tion, is turn­ing to scru­tiny of the RBI bal­ancesheet. A cen­tral bank’s bal­ance-sheet can­not be ex­am­ined on the lines of a cor­po­rate bal­ance- sheet. When the cen­tral bank shows high prof­its, it of­ten in­di­cates that the econ­omy is pre­car­i­ously placed. Per con­tra, when the cen­tral bank shows low prof­its as its for­eign as­sets form a larger pro­por­tion of its as­sets, it re­flects strength of the econ­omy.

The Gov­ern­ment is wel­come to study the RBI bal­ance- sheet and, in fact, should do so to bet­ter un­der­stand the cen­tral bank’s im­per­a­tives. If in­ter­est is paid on CRR balances at 7 per cent per an­num, the RBI would have to pay out about Rs 20,000 crore by way of in­ter­est. The in­cre­men­tal CRR balances in a year would be around Rs 38,000 crore and, as such, over one half of the CRR balances would be paid back to the banks thereby erod­ing mone­tary con­trol.

In 2011-12, the gross in­come of the RBI was Rs 53,176 crore, of which Rs 27,025 crore was trans­ferred to the in­ter­nal re­serves. The in­ter­nal re­serves of the RBI may ap­pear large, but they are equiv­a­lent to less than 10 per cent of the RBI’s to­tal as­sets, which is very low, given that from time to time, the RBI could face many de­mands on its in­ter­nal re­serves.

In June 1993, the in­ter­nal re­serves of the RBI fell to as low as Rs 843 crore and the RBI could have gone un­der. Thus, re­duc­ing the pro­por­tion of in­ter­nal re­serves rel­a­tive to to­tal li­a­bil­i­ties could be haz­ardous.

Of the to­tal ex­pen­di­ture of the RBI of Rs 10,137 crore, 70 per cent is non-es­tab­lish­ment ex­pen­di­ture, such as bear­ing costs on be­half of gov­ern­ment for se­cu­rity print­ing charges and agency charges paid to banks on be­half of the gov­ern­ment.

Pay­ment of in­ter­est on CRR balances will re­quire about Rs 20,000 crore per an­num, which will erode profit trans­fer to the Gov­ern­ment.

The RBI can­not pay in­ter­est on CRR balances and have suf­fi­cient sur­plus to trans­fer to Gov­ern­ment. At the same time, the CRR as an in­stru­ment of mone­tary con­trol can­not be dis­pensed with for at least the next 20 years. Thus, the SBI Chair­man and the Gov­ern­ment should stop look­ing for a black cat in a dark room which is just not there!

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