The central bank should be allowed to decide what is the best long-term route

As reported by this paper in the Monday edition, the government is considering the issue of float rate notes and buying to cool down the yield. The government is the biggest borrower in the country. Any rise in interest rates has the biggest impact on its finances and hence its worries are well understood. But, there are few aspects which policy makers should accept and keep in mind while taking any step. In the financial markets, whether debt or any other, only tinkering by the government or the regulator is accepted. Every government does this to influence the overall economic environment of the country. However, the attempt to give firm direction to prices of any asset in either direction is never liked by the market. There are enough examples in the global financial history where an attempt to give direction to asset prices has not only fallen flat but also done more harm than good to that segment of the market which has taken a long time to repair. Also, such attempts caused collateral damage to other segments of the financial market and economy. So the message should be: please do try more instruments so that yields do not witness any volatile spike but do not overdo it under the assumption that the government can do anything. Yields are determined by simple demand and supply of money and that has been changing for the last couple of months. In fact, some of the public sector banks had been marginally hiking their lending rates even before RBI increased interest rates at its last policy meeting.

Our policy makers must realise that interest rate trajectory has changed globally and when global events are the main influencers, nothing much can be done. It is not only in India that yields have risen. This is a phenomenon that has hit all emerging markets. Indeed, the taps of central banks — which were the source of excessive liquidity around the globe — are now closing one by one. While it was the turn of the US Federal Reserve to slow its money-printing machine, last week it was the turn of the European Central Bank (ECB) to announce the slowing down of its money printing machines. Soon will come the turn of the Bank of Japan and the Chinese central bank to reduce the pace at which they are generating liquidity. In China’s case, they would probably wait for the actual trade war between US and China to pan out before a decision is taken in the matter. The hard fact is that the days of easy and overflowing liquidity in global markets — which had been prevailing for the last 10 years — are over. This means that the cost of capital is going to rise worldwide and during this period assets which are of lower risk in term of currency risks are the ones that will be pursued much more than emerging market assets, be it equity or debt.

 Now comes the question of what the government can do at this point of time. The RBI should be allowed to decide what is the best long-term route to be taken when it comes to issuing of instrument. If its feels that more instruments are required, then let it go ahead with them. The government should not force its will on RBI, either directly or by giving it a gentle nudge on what needs to be done and at what pace it needs to be done. The RBI has a proven track record on these matters and it knows how to deal with a situation when the interest rate curve is moving upward.

The only thing the government can do is focus on unclogging the banking system so that credit growth picks up. While the cases are going to National Company Law Tribunal under Insolvency and Bankruptcy Code, it is taking a lot of time for them to settle. This was expected. The government need to push the cases so that resources lying idle do not stay that way for long. When an issue gets resolved, it unshackles a lot of financial and physical resources. These return to the system and that is what pushes up growth.