The Hindu Business Line : On deficit matters

Deficits obviously mean that expenditure is more than receipts. Revenue deficits occur when revenue expenditures are greater than revenue receipts. Revenue receipts include the sum of net tax and non-tax revenues while revenue expenditure includes items such as Defence salaries, subsidies, grants to States, and pension payments. The Budget estimate for revenue deficit for FY-08 is Rs 71,500 crore, which is 1.5 per cent of GDP.

Fiscal deficit is the difference between total revenues and total expenditure. Total revenues include all the previously mentioned revenue receipts plus non-debt capital receipts, such as recovery of loans and receipts from privatisation.

Total expenditure is the sigma of revenue and capital expenditure. Capital expenditure includes loans, Defence spending on equipment, infrastructure spending, and so on. The Budget estimate for fiscal deficit for FY-08 is Rs 1,50,900 crore, which is 3.3 per cent of GDP.

CRR, REPO effects

I would like to know what CRR and repo rates are and how they impact inflation?

Abhijith K, e-mail

Repo rate is the rate at which the RBI lends to commercial banks. The current repo rate is 7.5 per cent. CRR, or Cash Reserve Ratio, is the percentage of deposits that commercial banks must necessarily maintain as cash.

The CRR is mandatory and announced by the RBI. The current CRR is 6 per cent. In other words, if a bank has total deposits of Rs 100 crore, it must keep Rs 6 crore in cash or equivalent without lending to anyone. In effect, it is a dead asset for the bank.

Inflation is defined as "too much money chasing too few goods." So, in effect, what this statement implies is that inflation can be reined-in by either reducing the amount of money in the system or by manufacturing/producing more goods.

The RBI can only deal with the former and not the latter and the two weapons in its arsenal are the Repo rate and the CRR. The key difference on how a hike in the repo rate and that in the CRR work is that the former reduces or at least tries to reduce the demand for money by making it more expensive.

When the repo rate is hiked, banks have to pay more to the RBI to borrow money. They in turn will increase the rate at which they lend to end-consumers. An increase in the CRR straightaway reduces the amount of money in the system because banks will have to keep more money as reserves. It was estimated that the last time the RBI increased the CRR by 50 basis points, Rs 14,000 crore went out of the system.

This again makes money more expensive because there is less of it. Therefore, the end result of hikes in the repo rate and CRR are the same but the routes are different.

However, the time it takes both measures to have an effect on inflation is the key. It needs to be necessarily understood that hiking the repo rate or the CRR will not have an immediate effect on the inflation rate. Typically, it takes around six months for monetary policy to take effect.

Sunil Rongala

Group Economist

Murugappa Group

(Send in your queries on economics to Whackonomic@gmail.com)

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