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By A Vasudevan
It is now more than a month since the August monetary policy changed perspectives from an almost exclusive focus on the policy rate to the importance of managing the liquidity position in the system. This critical change in the last monetary policy statement deserves to be commended. Its value and significance can be seen in the midst of the current economic upheaval and geopolitical turmoil caused by America’s discriminatory and selective tariffs without any rationale, and with the added uncertainties brought by the hefty USD 100,000 fee for every new H1B visa.
Store of value is critical for trade settlement between two types of assets without involving cash transfer. But this could constrain the effectiveness of monetary policy
The prospect of good growth during the current fiscal year should not overlook the criticality of liquidity for the next monetary policy as liquidity is the key for developing financial markets and for initiating optimism for increased private investments. The Government on its part fostered the domestic demand potential by supportive direct tax changes and more recently goods and services tax reforms. These policy initiatives one hopes would help substantially address the tariff challenge posed by the United States government.
The surge in liquidity in the banking system is now estimated at anywhere between Rs 3-4 trillion
The August policy pause appears close to one of the mantras of the “new” financial economics that prevailed in the 1980s and 1990s, distinct from the later day modern monetary theory (MMT). The former emphasises financial constraints and seeks to limit government deficits. In contrast, MMT posits that for a sovereign government empowered to issue currency, public debt is not a constraint but a policy tool and the related interest rate dynamics fall in the jurisdiction of monetary policy, given the exchange rate regime.
The surge in liquidity in the banking system is now estimated at anywhere between Rs 3-4 trillion. As commercial banks are flush with funds, they will need to find outlets for loan-making and investments in different assets including government securities and to an extent the standing deposit facility available at the Reserve Bank. If for some reason, banks’ loan portfolios do not grow sufficiently, their investment portfolios would have to, by implication, bulge. Mutual funds would get more funds and corporate bonds of triple the A kind and new issues of companies would report gains in terms of funding. Stock markets would perform well.
The preferential choice among assets would be guided essentially by three criteria--safety (relatively high risklessness), rate of return and liquidity. Clearly some liquid assets will acquire the status of ‘moneyness’ and would be traded fairly easily with other assets depending on the holders’ preferences. For instance, if an individual, say, ‘A’ has treasury bills and wants to acquire shares of a company or a cluster of companies, the search for trading for such shares would begin.
If for some reason, banks’ loan portfolios do not grow sufficiently, their investment portfolios would have to, by implication, bulge. Mutual funds would get more funds and corporate bonds of triple the A kind and new issues of companies would report gains in terms of funding
In case entity ‘B’ with company shares is willing to acquire government securities from ‘A’, a trade settlement between the two types of assets without involving cash transfer could occur, though the terms of settlement would still be in terms of the unit of account, namely ‘money’.
Here, as we can gauge, trading between assets that have store of value is a critical pointer for the Reserve Bank to take note of situations where crypto assets including the recently mentioned, stable coins, that are not as yet given any official recognition, could also be part of transactions. But it is important to recognise that crypto assets are very much present all over the world. In fact, they are said to be prominent in sizeable amounts (estimated at about US $4 billion and over) now in India, thereby pointing to the preference of economic units for cryptos in addition to other assets as store of value. As is known, the current budget has provided for crypto tax.
It is therefore important to communicate clearly the position of the government on cryptos. Assuming that cryptos would be recognised, the Reserve Bank would need to work out, in close collaboration with other regulators in India as well as the fiscal authorities and other countries where cryptos are not banned, a regulatory framework for trading among financial assets with or without attendant cash movement.
It is important to recognise that crypto assets are very much present all over the world
What if transactions are conducted in the new issues or primary markets by the two parties or by only one of the parties preferring to acquire a secondary market asset from the other party, without involving cash transfers but with a transfer of IOUs or some such paper that would be valid for settlement at a future date that would go beyond the current period? Will this in any way constrain monetary policy effectiveness? What if assets (cryptos, stable coins or some such kind) are traded freely in the assets markets? Do these challenges not impact the effectiveness of monetary policy, with the chances of generating possible financial stress?
Economic analysts may also need to revisit data on savings of households and corporates as financial markets grow, and new financial engineering tools emerge. Such an action would help estimate the correct investment rate that plays as critical a role as productivity in growth estimations.
(The writer is a former Executive Director, RBI, and currently an independent analyst)