In the ’90s, the long-term policy goal was to eliminate CRR or bring it down to a minimum level like 3 per cent, since it was viewed as a distortionary tool of monetary policy. This goal has been abandoned, with CRR at 8.25 per cent. Yet, India is not China, where CRR has been pushed up to 17.5 per cent. Even if RBI is not making progress on the task of eliminating CRR, there are limits to how much CRR can be raised. Hence, from January 2007 onwards, M3 growth has generally exceeded 20 per cent on a year on year basis.

What has this policy mix achieved? Inflation continues to be a problem, for M3 growth should not exceed 15 per cent if we are to have inflation of 5 per cent or below, with 8 per cent GDP growth. Industrial growth has decelerated sharply, thus “cooling down” the system. By shifting the cost of the dollar peg from the government, the fiscal cost has been lowered, at the expense of lower economic growth.

For long-term observers of the Indian economy, none of this is surprising. In the ’90s, we had a similar story unfold. RBI pumped liquidity into the system while implementing a dollar peg, in an attempt to help exporters. They then used CRR hikes to undo these effects. This helped generate a collapse in industrial growth.

Who is responsible for the decision to return to using CRR as the way to control liquidity? Was it the government that forced RBI to keep the fiscal cost of MSS low? Or, was it RBI, in its enthusiasm to protect the interests of the government in its role as banker to the government, that chose to hurt industry and households it is not answerable to?

... contd.