RBI leaves some questions unanswered

A. Seshan | Updated on January 22, 2018

Seeing red: Prices could pose problems soon

It did well to hold the status quo on key rates, but should look more deeply into the process of monetary transmission

In its latest bimonthly policy review the Reserve Bank of India (RBI) has chosen to retain the policy rates (including the Cash Reserve Ratio). The Bank has clearly explained the rationale for its decision not to make any changes in its policy. It fears an uptick in inflation by December end. I feel that the rising trend may continue beyond the end of the year.

The Pay Commission’s recommendations and the OROP implementation will pump considerable money into the system in the near future. The impact on the salaries of State government employees can easily be gauged. How fiscal consolidation will be achieved with a reduction in the fiscal deficit remains to be seen. In the press conference there was a reference to the possible tightening of government expenditure to compensate for the rise in government salaries. We know from past experience that with a substantial proportion of the Consolidated Fund of India being pre-empted by prior commitments like establishment expenditure, pension, debt service, etc., the axe is likely to fall on capital expenditure, affecting economic growth.

Scope for raising revenue

There is scope for raising revenue but faced with a number of State Assembly elections in the near future and the dismal record of BJP in Bihar elections, it is doubtful whether the government will bite the bullet and go ahead with additional revenue measures. There appears to be a decision on dropping a number of tax exemptions for the corporate sector.

The Government should think of a flat tax for personal incomes by fixing a single rate, enhancing the exemption limit and doing away with deductions and other concessions. There is enough evidence available from other countries which have adopted a flat rate for personal income tax to know the effects. The ingenuity consists in fixing the new general exemption limit and the flat rate to be adopted. There is enough time available between now and budget formulation for the North Block to do the needed exercise. A flat tax can help in better compliance with the income tax law and consequent increase in revenue. The introduction of GST will also contribute to the mobilisation of resources.

Depreciation of the rupee

In the review there is no mention about the effect of the depreciation of the rupee on the domestic price level. The advantage of the steep fall in oil prices, which touched $50 per barrel, on the balance of payments has been nullified by the depreciation of the rupee. There was a reference to exchange rate in the press conference when the official policy not to determine the forex value of the rupee but only stabilise the market by dealing with volatility in rates was reiterated.

Although the forex reserves are comfortable it is time now for the RBI to boost them further. Measures undertaken to encourage capital inflows will have a sobering effect on the exchange rate. The full potential of the enormous wealth of the Non-Resident Indians (NRIs) has not been tapped. Although some relaxations were made in the rules governing the collections of NRI deposits there is a need to review what further action is required to encourage the NRIs to transfer their deposits in Western banks to India.

The rates are low in foreign banks and they can be induced to park their funds in India on a larger scale than they have done so far. The important and radical steps taken during the Gulf Crisis of the 1990s and their effect on forex reserves can be reviewed to examine what incentives the banks need to mobilise the NRI deposits on a larger scale than they have done so far. They should be encouraged to lend forex loans to Indian business on better terms that what they enjoy now in the international market.

Interest rates

The RBI has pointed out the limited effect of its reduction in policy rates on lending rates. It has promised to bring out a paper on setting the marginal rates of resource-raising as a basis for fixing lending rates. There is a vast unorganised money market in the country. Although it has reduced in size over the years, especially after the commercial banks entered rural areas, still the hold of the moneylender is present. Even at the current rates and with the prescription of priority sector advances it should be possible for the borrowers in rural and urban areas for productive purposes to find bank loans relatively more attractive than those of the private sector.(There is interest subvention for farm loans.)

There is no reference to the extent of indebtedness in the country with the suspension of all-India surveys by the RBI which was done with the help of National Sample Survey. We have not seen any survey result in the recent years. The RBI also stopped conducting the annual follow-up rural credit surveys in selected districts many years ago. They were useful in understanding the rural credit situation.

The Report on the last such survey (7th Follow up Rural Credit Survey) entitled “The Small Farmers” (1967-69) received wide notice and was appreciated by President McNamara of World Bank and the ESCAP of UN in Bangkok. The latter found it timely and useful as its theme for its annual report was small farmers. The RBI should consider reviving the Division of Rural Surveys to conduct periodical rural surveys in limited areas through field investigations.

The writer is a Mumbai-based economic consultant

Published on December 01, 2015

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