The Hindu Business Line : Report on Currency and Finance 2003-2004: Reflecting an upbeat business outlook

WE have had a profusion of progress reports on the Indian economy in recent weeks, the most recent being the Finance Minister's report on the fiscal outturn following the requirements of the Fiscal Responsibility and Budgetary Management (FRBM) Act. The latest to hit the headlines is the RBI's Currency and Finance Report for 2003-04. Although it pertains to the previous year, it has appropriately covered the developments in the economy during the first half of this year.

Following the practice of the last few years, the RBI has also enriched the report with theoretical discussions on the evolution of monetary policy in the perspective of an increasingly open economy. These latter discussions are highly interesting, but have a heavy overburden of econometric theory and associated jargon, perhaps inevitable in dealing with such a complex subject.

The report enumerates the various developments in the economy over the years. It points out that the current trend of growth dates back to the reforms of 1991, which covered a whole spectrum of sectors. 2003-04 was particularly characterised by a high rate of GDP growth. The 2004-05 period started well, but the monsoon weakened soon thereafter.

There was also the aftermath of the global crude oil price rise impacting growth and inflation. The recovery of agriculture from the previous year's drought, however, drove the growth of the overall economy to a high 8.2 per cent in 2003-04. Industrial production benefited from robust external and domestic demand.

The services sector also showed rapid growth, driven by trade, hotels, transport and communication, besides external demand for outsourcing. Based on the recent trends in the economy over the first half-year and its assessment of the prospects for the world economy, the central bank seems to be sticking to its earlier forecast of 5.6-6.7 per cent for 2004-05. In agriculture, the report points out that crop production prospects during the Kharif season have been subdued. The recovery of the South-West monsoon and the satisfactory North-East monsoon are expected to lead to a recovery in rabi production.

The report lays stress on the success of the various schemes initiated by the bank for increasing agricultural production, including higher access to credit. It notes that procurement of foodgrains up to end November 2004 was higher than in the corresponding period last year.

Off-take was, however, lower, showing adequate availability of foodgrain supply in the market. Stocks with the Government continue to be higher than the norms for buffer stocks. The impact of the recent tsunami disaster is, however, still to be worked out in respect of demand for relief supplies. Overall, the country's industrial outlook appears robust. Particularly of interest is the fact that it shows a higher rate of growth in respect of capital goods. This shows the positive nature of the growth momentum of the economy. The rate of growth in 2003-04 was 13.1 per cent — the highest in recent times. What is of interest to the lay observer of the economy is the general improvement in industrial outlook mentioned by the RBI report. Business expectation surveys, in general, support an upbeat outlook.

According to the bank's industrial outlook survey, expectations on the business situation for the quarter October to December 2004 show a higher level of confidence compared with the previous quarter. This is supported by other surveys of business confidence conducted by such organisations as the CII.

Turning to the fiscal situation, we can scarcely hope for the RBI to improve on the details of the results reported by the Finance Minister in his latest progress report on the FRBM Act submitted to Parliament. However, for what it is worth, the apex bank notes that the gross fiscal deficit during the first half-year was lower than in the previous year. It also notes the decline in capital expenditure. Central finances have been comfortable, in general, leaving behind a sizeable cash balance with the central bank. The RBI comments, however, that State governments continue to show strain in their fiscal position. On the price situation, the report on currency and finance reiterates that inflation is hardening worldwide, albeit from very low levels, on the back of elevated commodity prices.

As it points out, central banks around the world are withdrawing their soft accommodative stance by raising key policy rates in a measured manner. This is a firm enough indication that the RBI cannot be far behind with a harder stance in respect of interest rates if inflation continues to rise.

Inflation in India has increased in 2004-05, reflecting supply-side factors, the failure of the South-West monsoon as well as the increase in global prices of commodities such as oil, steel and coal. But inflation in terms of WPI reached a peak of 8.7 per cent by mid-August from 4.6 per cent in March 2004, reflecting the pass-through of global oil price rise.

Through various counter-measures, essentially on the fiscal side, inflation has come down to 7.3 per cent in November and to 7 per cent in December 2004. The RBI, however, notes that consumer price inflation has been relatively moderate, rising to 4.6 per cent in October 2004 from 3.3 per cent in October 2003. Over time, however, the WPI increases get reflected in the CPI figures.

On the external account, the report has a creditable and credible story to tell. On the top of a perceptible increase in exports led by manufacturers and services, there has also been a remarkable rise in invisible receipts, particularly from remittances and software earnings. The net result has been that the current account was in surplus during April to June 2004 compared to a deficit in the corresponding previous period.

On top of this has come the continuing inflow of capital, both FDI and FII. As the report notes, India ranks high as a destination for FDI, next only to the US and China.

Hopefully, this will be kept in mind in deciding on FDI policies, in respect of the pulls and pressures of coalition partners. The report notes that there has been a marginal outflow on NRI deposits due to adverse change in interest rates. Overall, however, India has had an enviable year on the external front so far, with forex reserves climbing to $130 billion. The prospects for the year are good with a comfortable forex reserve and a manageable inflationary situation. The report points out that the RBI has successfully sterilised the impact of these increases in reserves by resort to market stabilisation bonds. These, however, involve a quasi-fiscal cost. What India has to do to deal with its cornucopia of forex is still a matter of debate in economic and political circles.

The report on currency and finance does not address this critical policy issue, particularly what we can do with our continuing embarrassment of forex riches and whether, for instance, we can use the forex to strengthen the country's infrastructure instead of lending it to developed countries to improve their own capital investments. But that perhaps is beyond the remit of the report.

The ideological battle between proponents of the use of forex reserves for infrastructure is being fought in North Block, South Block and the Yojana Bhavan. One can, however, be confident that given the current constellation of intellectual eminence in all these three centres of power in India, a pragmatic and sensible solution will soon be arrived at — which will enable the optimal use of our reserves in the country's best interest. Perhaps, a modification can be to set up a SPV for infrastructural projects, where the RBI can invest in equity. The SPV can then invest in infrastructural projects, assuring itself that reasonable returns can be secured through appropriate concession agreements enabling tariff adjustments to cover costs fully and earn profits.

This device will help the central bank to avoid violating the binding restrictions of the FRBM Act, inasmuch as the RBI's equity investments do not constitute borrowing from the central bank, which the FRBM Act prohibits. If there is a will, there can be a way out of FRBM's (self)-imposed restrictions on investment.

Ultimately, the RBI and the Government have to agree on using what they own jointly — the reserves for investment. To cite FRBM as an impediment invites the retort that we should amend FRBM Act to accommodate the change in use of forex reserves for our own good instead of that of G(7) — the richer half of the world. The above issue will hopefully be dealt with the in the next year's report on currency and finance and will address it in sufficient detail for the public at large. At the moment, the dons are fighting it out, in the best intellectual tradition of both the Government and the RBI, aided and promoted by India's economic leaders — the RBI Governor, Dr Y. V. Reddy; Deputy Chairman, Planning Commission, Dr Montek Singh Ahluwalia; the Finance Minister, Mr P. Chidambaram, and, above all, the Prime Minister, Dr Manmohan Singh.

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