With a
fiscally expansionary budget, the RBI will once again have to keep a close watch
on the monetary situation. So expecting interest rate cuts at this point seems
counter-intuitive
It’s odd, but somehow the heart goes out to RBI governor Y V Reddy. Yet again, the bill for the party will end up on his desk. Given the pile-up of other issues that require the governor’s full-time attention, the additional cost of reining in the after-effects of finance minister P Chidambaram’s budget jamboree is sure to extract a heavy toll.
Sure, the
FM has done what he had to, given the circumstances. Some may even argue that
his hand was probably forced to a certain extent by a party diktat. The Rs
60,000-crore farm loan waiver and his petulant response to repeated questions
about it betray some of the occupational hazards of framing a budget during
election times. But, to his credit, he has still tried to focus on the larger
issue at hand — keeping the economy humming and trying to insulate it, as far as
possible, from the shock waves of an impending global slowdown. This he has
tried to achieve through two measures — trying to ensure that consumption growth
in the economy continues apace and that the engine of industrial production does
not slow down. At this stage, he is keen to achieve these ends with the help of
some fiscal stimulus.
Look at
what the FM is up against — the average growth of industrial production has
dropped from 11% at the end of the last fiscal year to a monthly average of 9%
till November. In December, it was only 7.6% and, if the average industrial
production growth rate tends to stay between 5-7% in the second half of the
year, the average rate for the year is likely to be below even 9%. That’s a
sharp drop from the previous year. The main items dragging the index down have
been consumer durables and the auto sector.
The
Economic Survey also forecasts that the year is likely to end with an overall
real GDP growth of 8.7%, a full 100 basis point lower than the previous year’s
9.7%. Add to this the fear of the unknown — no fix on the extent of the sub-prime
damage in the western economies and the resultant economic slowdown, or the
degree to which this event will
impact the Indian economy.
So, how
will the finance minister achieve the twin objectives? For the consumer, he has
done two things — made goods cheaper by cutting excise duty and providing them
with more spending power by restructuring income tax slabs. With an eye to the
industrial production index in particular, he has reduced excise duty on small
cars and two-wheelers (sales of which had been hit the hardest). He has also cut
the median excise duty rate to spur consumption of daily household items. Given
that a large part of the growth impetus during past few months, in the face of
slowing down consumption, has been predicated on investment, the FM has
introduced some policy changes in the budget to keep the momentum going —
removed some long-standing glitches to facilitate higher trading volumes in
corporate bonds, promised to develop a bond and currency derivatives market,
extended tax breaks for construction of hospitals and hotels.
It’s too
early to figure out whether this
combination will indeed work in spurring higher consumption levels and therefore
keep the industrial shop floors buzzing. But one thing is certain: not
addressing the real issues is unlikely to sort out the inflation issue or
immediately bring people back into the consumption mode. Take the pressures on
the food economy. Is it going to go away with the Rs 60,000-crore farm debt
waiver?
Unlikely,
since the farmer still has no solutions on sourcing improved inputs (such as
seeds or fertilisers) or even an efficient and reliant system for selling his
produce. There is also no appreciable investment in improving the infrastructure
which delivers agricultural produce from the farm gate to our plates. Therefore,
despite the FM’s pious statements about inflation in his budget speech —
“Keeping inflation under check is one of the cornerstones of our policy” — food
inflation (spurred on to some extent by global factors) is likely to continue to
haunt the economy for some more time to come. The Economic Survey
observes: “The behaviour of agricultural prices, including essential consumption
items, will be critical, given falling poverty and rapidly rising per capita
income…Domestic supply management is…critical to stabilising inflation
expectations, moderating pressures for upward revision in wages and prices, and
containing pressures for cost push inflation through monetary and fiscal
accommodation.”
Second,
will lower car and two-wheeler prices (assuming all the auto producers do agree
to pass on the duty cuts) really inspire consumers to be liberal with their
wallets? Again, doubtful. A careful look at the auto industry sales figures
reveals that it was actually lower interest rates that catalysed record sales of
the past couple of years. Once rates hardened, sales also dropped. Therefore, to
get those motorbikes and tiny cars rolling out of the shop once again, what’s
needed is not only a firm control on current inflation, but on expectations of
what it’ll be in the future. Since the fiscal design does not explicitly state
how it will lower inflationary expectations — and hence interest rates — in the
next few months, the efficacy of the entire package is on test.
But,
beyond that, the RBI will have its own set of headaches arising out of the
budget and other public policy. For one, its authority as an enforcer of credit
discipline in the banking system seems to have been undermined once more by a
trigger-happy government. Second, the pay commission’s award is surely going to
add another little twist to the on-going inflation story.
In
addition, the RBI has used monetary policy in the past few months to bludgeon
runaway demand and bring inflationary pressures under control. With such a
fiscally expansionary budget, the RBI will once again have to keep a close watch
on the monetary situation. So expecting interest rate cuts at this point seems counter-intuitive. Unless, of course, the RBI also decides to join in the
pre-election giveaway party.
Published as an Op-Ed in The Economic Times (March 6, 2008)
