More to policy than rate cut

The Reserve Bank of India’s annual review of monetary policy is an eagerly awaited event, more so when a rate cut is anticipated. However, the key policy shifts required to address the nation’s macroeconomic problems lie elsewhere.

It is wrong to believe that monetary easing by itself can stimulate growth and reduce inflation in the face of massive supply-side rigidities, particularly with respect to food. The time has come for relevant stakeholders to move beyond rate reduction and shift their emphasis on other policies --- fiscal, agricultural and institutional.

Optimists argue that since the last mid-quarter monetary policy review in March, a there has been a trend reversal in the inflation-growth dynamic for the better.

A slowdown in the growth of the wholesale price index (WPI) to a 3-year-low, a consequent decline in short-term borrowing rates, a benign outlook on global commodity prices and some early policy action by the newly-established Cabinet Committee on Investments, especially in the power and oil and gas space, are cited as evidence that the ‘green shoots’ are beginning to sprout.

Adding to the optimism is the expectation of a “favourable monsoon” this year and the need for the RBI to factor the same into food price inflation while determining its benchmark policy rates in the upcoming review.

PERSISTENT INFLATION

However, it is important to highlight that a three-year low in WPI growth, while positive, is not the same as a reversal in absolute price levels.

A high ‘base effect’, conceals the high level of absolute prices. It is also important to note that the growth rate in CPI (Consumer price index numbers that are more representative of inflation related to the consumption basket) remains sticky in double digits at 10.4 per cent.

The persistent gap between WPI and CPI over the last eight quarters reflects, among other things, distribution bottlenecks in the ‘farm-gate to plate’ food chain.

Optimal levels of rainfall, or record levels of rabi output may not substantially ease food inflation expectations, so long as transaction costs and inefficiencies in the food chain remain unaddressed.

FISCAL DEFICIT

The Finance Minister has promised a reduction in fiscal deficit to 4.8 per cent in 2013-14. Beyond the apparent statistics, there are two dimensions of the deficit, however, that require urgent introspection.

First, the qualitative nature of India’s fiscal deficit is steadily worsening i.e. the ratio of revenue deficit to gross fiscal deficit has deteriorated from an average of 54 per cent in the 1990s to nearly 75 per cent in 2011-12. This poses serious challenges to the ability to channel scarce resources in productive sectors and accentuates the vicious cycle of indebtedness to meet revenue expenditure.

Subsidies, wasteful expenditure and presence of the state in non-desirable areas have played a pivotal role in ensuring that this imbalance remains elevated.

Second, the real measure of India’s deficit position is brought out by including the State governments’ statistics.

If that is done, the overall shortfall is nearly 7.5-8 per cent, among the highest for frontline emerging economies.

However, the current move towards fiscal consolidation by State governments raises questions about the quality of fiscal adjustment.

There is evidence of cutbacks in growth-oriented expenditure, sluggish own tax revenue and own non-tax revenue trends, and lack of fiscal capacity building. A fiscally strong Centre (for resource transfer) and a responsible State government (for social sector investment and enhancement of the human development index) are a pre-requisite to spur productive investments.

The clamour for monetary easing from certain segments of the banking sector, almost as a panacea for all evils, masks the substantive issues in the sector. There are significant opportunities for overcoming operating inefficiencies.

BANKING INEFFICIENCIES

Other troublesome issues are: excessive net interest margins, indicating lack of adequate competitiveness in the sector; absence of tighter credit risk standards; robust surveillance and post-sanction monitoring of bank lending; and a patchy record in enhancing financial inclusion.

This last issue is especially important. A recent RBI study says that 14 States in India had a low financial inclusion index value of less than 0.3 (on a scale between 0 and 1).

These States account for nearly 55 per cent of India’s population. Not surprisingly, many of these States also rank low on per capita incomes and overall development.

Any analytical discussion around monetary policy transmission effectively skirts a vast majority of the unbanked population these States.

In sum, a focus on monetary easing leaves out a host of structural issues.

(The authors are professors at S.P. Jain Institute Of Management and Research, Mumbai.)

COMMENT NOW