The Hindu Business Line : Economy faces inflation, deficit woes

The cost of money, especially for SMBs, is out of whack with interbank rates, i.e., the intermediation costs are too high. It is not ‘financial inclusion’ but ‘financial exclusion’ at play.

S. Balakrishnan

Indian inflation is rising rapidly, topping 5 per cent in the latest data. There was an across-the-board increase in all products and goods segments, killing hopes of a near-term RBI rate cut. The only thing that could cause the central bank to act would be the Fed pushing down its benchmarks another 50-100 bps – which is quite on the cards, given the sharply deteriorating US economy.

The domestic fiscal position is none too good. It has now become customary for the Government to issue bonds to compensate cost increases (eg., of the oil companies, because of rising crude), finance investments (eg., in the SBI) or for subsidies (eg., for fertiliser companies). Normally, these outgos would be met from market borrowings. Instead, by ‘gifting’ its bonds to the ultimate recipients of Government funds, the burden of market borrowing is, in effect, shifted to them. Interest servicing the bonds would easily need around Rs 10,000 crore every year, not counting that for the Market Stabilisation Scheme (MSS) bonds to sterilise excess liquidity, which is another more or less equal amount. And just ahead is the Sixth Pay Commission award, whose impact is not known yet, but will surely be significant.

Thus the buoyant tax collections of the past year and more must meet new expenditure demands. Whether tax revenue will stay at the same levels this year is a question mark. Much depends on the performance of the economy and if it can ‘decouple’ from the woes of the US service sector (capital markets, real estate) activity is at the risk of a decline. Service tax income, which has been strong in recent years, could take a hit.

Dilemma

The RBI is on the horns of a dilemma. At the moment, however, its pangs are not deep as those of the Fed. The economy is holding up. Asset prices have cooled somewhat. That may actually be welcome. For, it was surging stock and property prices that were the most worrying signs of the economy overheating.

Actually, ‘decoupling’ but of a different sort ought to be the concern. The cost of money, especially for small and medium-sized businesses, is out of whack with interbank rates, i.e., the intermediation costs are too high. It is not ‘financial inclusion’ but ‘financial exclusion’ at play.

In turn, that arises from the interbank market-disconnected deposit rates that banks pay not only for bulk but also retail deposits.

It is an issue that needs to be urgently addressed. Otherwise, the central bank’s policy actions will not transmit in quantum and time, as intended, to the market to achieve the desired effects on the economy.

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