Do we really need a Central Bank in India?

This is a question that requires deeper thought. My friend Amol Agrawal (see the earlier blog wherein we are debating monetary policy issues; you can also see his blog https://mostlyeconomics.wordpress.com) has compared the working of the banking market to the stock market. The SEBI is a market regulator in the stock market. While the SEBI regulates, it does not really set the prices of the stocks.

Can’t we have a similar model in the Central Banking space?  So why can’t the RBI be just a regulator? Why does it have to control the interest rate regime in India?

Here are some views.

Indian interest rates are not controlled by the RBI

Well, firstly, in India, we do NOT have an administered interest rate regime. We haven’t had that for years now. So, the RBI does not act as a super controller of the interest rates but yes, to say that it does not give guidance on the expected movement of interest rates would be childish.

In fact, even today, when the review happened, one of the issues mentioned by the RBI Governor is that a reduction in repo is NOT translating into a reduction in the lending rates by banks. The lending rates of major banks were reduced after the repo was cut in three consecutive sessions by the RBI. Macroeconomists calls this to be the failure of the Monetary Transmission Mechanism and the RBI has kept on saying that this inelastic MTM does not allow it to influence business environment to the extent that one expects it to.

Call it failure of the MTM or whatever, but the fact remains that interest rates offered by banks do dance to the tune of their own analysis of the business environment though they do tend to have a correlation to the repo or other policy rates set by the RBI.

Thus, my first point is that we do not have a model in India where banks are totally controlled by the RBI into offering interest rates that they do not find appetizing.

Banking deposits are HUGE compared to savings in stock format

Second, can we really draw parallels between the stock market and the banking sector? I curiously went back to the Handbook of Indian Economy in order to see how the household financial savings are split between banking deposits and stock investments.

As per the 2014 data, Indian households hold 57.3% of their financial savings in the format of bank deposits whereas they only hold 4.2% of their savings in the format of shares and debentures combined. Further, 145 million out of our 245 million households have access to/ actually hold a bank account (Pre-Jan Dhan figures). That is, nearly 55% of Indian households have a bank account. Compare this to less than 1.5% of Indian households that take exposure to stocks.

It is obvious that interest rates as a “price” has a far far greater impact on the savings behaviour of Indian households as compared to stock prices.

Thus, my second point is that from a savings dominated growth perspective, its fairly important to have a mechanism that can offer a correction in the banking sector as compared to the stock market sector.

Banks affect real sector growth

The third point that I’d like to make here is that the most delicate link between the real sector and the money sector for any economy, is banks. Banks charge a lending rate that can fire up or dampen down investments. Banks also offer a deposit rate that can help channelize the savings of gold crazy and real estate crazy households towards financial savings. For a developing economy like India, a totally independent banking sector could cause extreme volatility in either savings or investment patterns, rendering our growth path more volatile.

Look at the track record!

The fourth and last point I offer is, if it ain’t broke, don’t fix it. I wouldn’t be too sure that Central Bankers are Central Planners “creating havoc with the system.” The RBI track record has been one with impeccable inflation numbers and a banking sector, which is hugely over-regulated, but has never once collapsed either!

However, I do hereby humbly submit that, to a person like me with free market leanings, the idea of a free banking sector is also very appealing. I am not saying this is a bad idea, I am saying it is a bad time in which to implement this idea.

As Mirza Ghalib would have suggested, “Dil ke khush rakhne ko, Ghalib, ye khayaal acchhaa hain!”

 

 

 

 

 

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