Second, banks are engines that carry growth to larger populations. Our credit penetration numbers are too small by any standards, and God knows that we need so many million more homes that bank loans can fund. What our banks need is size and autonomy. If credit/deposit ratios are too high, should it only mean that banks are taking mindless credit risks? Or could it mean that they are finding themselves in credit markets that are growing too fast for their size and capacity? Surely there are areas of concern in lending practices and recovery rates. But how much can credit policy do, by altering capital requirements and risk weightages, if bank managements do not have the incentives to de-risk their balance sheets in their own business interests? The risks of bank failures are perhaps higher from the current ownership pattern and the resulting moral hazard issues, than from loan defaults. There is also limited evidence that monetary policy can actually tweak bank balance sheets into better health. Let’s allow them banks to lend as much as they can, enabling them to find the money, based on their own strengths and size.

Third, the concern for inflation is central bankers’ dharma. Inflation hurts, and hurts the weaker sections more. Monetary policy can control inflation, only if it comes from a ‘too much money’ syndrome. We all know about the supply side constraints in our case. Central banks like to do something about inflation, anyway, using whatever tools they have. My suspicion is that we may be allowing the rupee to remain overvalued to keep this number down. The current account deficits have sustained, which means our currency should be depreciating. But it is not. An increasing inflow of global money into our economy is a reality. A central bank that worries about ‘liquidity risks’ from these flows, and the need to ‘manage’ currency impact could continue to allow the rupee to remain overvalued. That hurts export competitiveness and growth, though it keeps inflation low. What are we trading off?

... contd.