Why not a joint review of monetary, fiscal policies?

The Indian economy, which till a couple of years back was going strong and raising expectations of overtaking even China and other strong economies, has turned weak.

The US financial crisis of 2008, which brought down many economies, did not affect the domestic economy as the crisis was well managed both by the Government and the Reserve Bank of India.

In terms of broad parameters such as GDP growth, inflation, financial stability, exchange rate stability, and so on, the economy was doing well. But the situation changed since 2009.

Erosion of confidence

Many scams, one after another, were detected, revealing governance deficit. Corruption and black money attracted much attention and affected decision making at various levels.

Inflation raised its ugly head and continued to remain unabated. Industrial production declined, with hike in interest rates being cited as one of the major reasons for it. Infrastructure development did not get the priority it deserved.

Favourable monsoon did not bring down food inflation as supply chain constraints and periodical increases in fuel prices affected the marketing and distribution of food products at reasonable prices.

The trade gap widened due to increased imports and reduced exports. And exchange rate fluctuations added fuel to fire. The rupee depreciated by around 17 per cent since August 2011.

Administrative policies were not implemented as expeditiously as the economic conditions of the country demanded. Investments, especially FDI, slowed. And FIIs started pulling out their investments, creating volatility in the stock market.

The downgrading of the US economy and the European crisis have aggravated the situation.

Inflation focus

The Reserve Bank took a series of measures, basically to contain inflation. The approach was to make money dearer and reduce the purchasing power. The RBI raised the repo rate 13 times since March 2010, and brought it to 8.5 per cent in October 2011. The reverse repo was revised to 7.5 per cent and the Marginal Standing Facility was fixed at 9.25 per cent.

Interest rate on savings bank and NRE accounts was deregulated. And sensing the mood of the investing community against further interest rate hikes and seeing some respite in inflation, the RBI decided to keep the rates unchanged in its policy review in December 2011.

But production costs have increased, not only because of the hike in interest rates but also because of input costs going up, reducing thereby the profit margins and fresh investments.

The fiscal policies have not been moving in tune with monetary policies. The general opinion is that the RBI alone is taking action and the Government has been keeping quiet on various fronts.

Direct and indirect tax revenues, which are directly linked to GDP growth, have not been keeping pace with Budget expectations, and the Government is falling behind in achieving the disinvestment targets due to poor market and other conditions.

Infrastructure required for industrial production, particularly energy, has not picked up for want of fresh administrative policies and proper implementation of existing ones.

Fresh impetus

The economy needs a morale boost and this can come only from the Government. To start with, the Government and the RBI should jointly review the monetary and fiscal policies pursued so far and initiate measures to revive the confidence of the investors.

Since food inflation has started declining and the overall inflation is expected to fall to around 7 per cent by March 2011, the RBI can consider effecting some reductions in its policy rates.

Bank credit

The policies of banks should undergo some changes so as to attract more of production, rather than consumption, oriented credit.

Credit to agriculture, SMEs (small and medium enterprises), for exports and infrastructure need to be augmented, for which the Government should provide tax incentives and other logistical support to attract private investments.

NPAs (non-performing assets) of banks are on the increase for which the Government and the RBI should think of some self-liquidating mechanism, involving borrowers and banks, and leaving out other stakeholders of banks and taxpayers.

Bank capital

The capital of public sector banks need to be raised by about Rs 10,000 crore and, for this, the Government can consider issuing convertible bonds, making the banks bear the interest cost till such time the bonds are converted into equity shares.

The Government can consider giving tax exemption for investment in these bonds without affecting its own cash outflows or fiscal deficit.

Financial inclusion, bringing all categories of people engaged in some economic activity or other into the banking system, has to be made obligatory and both the Central and State Governments have to initiate action in consultation with the RBI.

All business establishments, irrespective of their size of operations, must be made to issue receipts for all their monetary transactions, indicating their registration and permanent account numbers. This would go a long way in making financial inclusion a reality.

The joint review of fiscal and monetary policies by the Government and the RBI should be done at periodical intervals, say, at least twice a year. Such an approach would help them to mutually appreciate the issues, if any, in the economy arising out of lack of coordination.

This would also help convince the business community about the Government's and the RBI's seriousness in achieving economic growth with price stability.

While the Government and the RBI can maintain their independence in framing policies, these will have the desired impact only when they are co-ordinated, and jointly reviewed and followed-up.

(The author is a consultant.)

COMMENT NOW