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There will be a glut of economic policy changes next week, which will keep the media and analysts working overtime.
The Prime Minister's Economic Advisory Council (PMEAC) has produced a slim power-packed review of the economy (February 2012). The Reserve Bank of India (RBI) mini review of monetary policy will be released on March 15 along with the Government's comprehensive Economic Survey.
This will be followed on March 16 by the all-important Union Budget for 2012-13. The close proximity of these policy announcements will put into bold relief the interaction of monetary and fiscal policies.
The discomfiture for the RBI would be that the monetary policy announcement will be a day before the Union Budget. The compact review by the PMEAC brings out a clear enunciation of the state of the economy.
The growth rate in the third quarter of 2011-12 is put at 6.1 per cent. Although the PMEAC puts the growth rate for the full year 2011-12 at 7.1 per cent, various other estimates put the growth rate at 6.5-7.0 per cent.
Official pronouncements project the growth rate in 2012-13 at 7.5 per cent. Given the adverse global economic situation, with the European economy in shambles and unemployment in some countries as high as 20 per cent, the Indian growth story has held up well.
Inflation worries
A redeeming feature of the Indian economy is the abatement of inflation in January 2012 to 6.55 per cent (as per the wholesale price index) and 7.65 per cent (as per the Consumer Price Index).
What is worrisome is inflation expectations are very high and there are fears of a return to double-digit inflation. Also, there is considerable inflation suppression in prices of petroleum products, fertilisers and food.
The Union Government finances are in disarray and the Budget Estimate of the gross fiscal deficit (GFD) for 2011-12 of 4.6 per cent is expected to cross 6 per cent, and that too after a degree of questionable financial engineering. The exchange rate is out of alignment and is grossly over-valued. The balance of payments current account deficit (CAD) in 2011-12 is expected to be 3.6 per cent of GDP, which would be higher than in the dark days of 1990-91.
The global oil price could work itself into an acceleration of inflation.
Capital flows can comfortably finance up to 2.5 per cent of GDP but beyond that the capacity to run a higher deficit becomes doubtful and very costly. Hence a downward adjustment of the rupee exchange rate could be unavoidable.
Domestic savings and gross fixed capital formation over the past four years show a slippage of 4 percentage points of GDP which would militate against the aspiration for higher growth rates in the ensuing few years.
Stimulus pressure
The RBI, with the unenviable task of announcing its mini policy review a day before the Union Budget, has to play its cards blind.
There are strong pressures on the fisc to provide a stimulus while at the same time raising revenues to undertake larger expenditures. As such, the fiscal policy space for a stimulus appears narrow.
Monetary policy also does not have space for relaxation. Banks are already borrowing an unprecedented Rs 1,80,000 crore through the repo facility at 8.5 per cent and with the pressure of tax payments by March 15, 2012, repo borrowings could rise to over Rs 2,00,000 crore; banks may need to also access the Marginal Standing Facility at 9.5 per cent.
Furthermore, the RBI has, in the current financial year, undertaken purchase under its open market operations to the tune of Rs 1,00,000 crore. The banking system's deficit is over 3 per cent of liabilities.
With borrowings under the repo at 8.5 per cent and investments in Certificates of Deposits at 11 per cent, there is considerable round-tripping of RBI funds.
Monetary control
An orthodox monetary policy would warrant an increase in the repo rate. There are, however, political economy considerations pressing for a reduction in the repo rate as also reduction of reserve requirements.
Acceding to these pressures could imply a loss of monetary control which would fan the inflation cinders.
Loss of monetary control and a weak fiscal resolution would imply a resurgence of inflation.
Forty years ago, the then Governor, S. Jagannathan, speaking at the Bankers' Club in Chennai, said “while planning their resource position, banks should not count upon recourse to the Reserve Bank as an easily available resource”.
Today, bank accommodation from the RBI has become a chronic addiction.
If not treated early, this would eventually require a cold turkey approach, which would be disruptive to the financial system.
The author is an economist. >blfeedback@thehindu.co.in )
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