Thursday, September 27, 2012

RBI versus PMEAC: Financial Express 24th August 2012

Apart from differing on the GDP forecast, RBI counters PMEAC projection of meeting the fiscal deficit target
RBI’s Annual Report, released just six days after the PMEAC’s Economic Outlook, is hard-hitting and gloomy at the same time. RBI has placed on record the hard reality that we should now see clearly and has also indicated that we need a very big overhaul of the way in which we operate, but this, unfortunately, does not seem to be forthcoming. While we cannot get help from the global economy, there is a pressing need for a domestic response, in the absence of which we cannot really hope to move to a different level of growth.RBI is clear that growth cannot be over 6.5% since the basic forces that are needed to move the economy are missing. Investment is down and the reason is ‘policy stasis’. The report is quite blunt in saying that we need to have the Singapore model in place where all the ministries sit together and sort out issues. The power sector has been pushed back due to the problems with coal allocation. Roads cannot be built because there are issues of land and environment, and progress in telecom is similarly afflicted with inaction. Quite clearly, there is a call for a shakeout in policy from the government on all ends. In fact, it goes head on to say that there is ‘absence of sufficient policy response’ which is required for any improvement to take place.By going into the reasons for inflation, RBI has actually highlighted two factors: one is the real reasons and the second is that there is a very strong reason for doing what it has been doing so far to control inflation, i.e. retaining interest rates at a high level. The report is critical of the MSPs for raising prices of food and has also highlighted that there is a rural wage spiral (is it MGNREGA the report is referring to?) at play somewhere, adding to demand through higher wages in the country coupled by higher staff costs in corporate India. This means there is reason to believe that there are demand-pull forces operating somewhere that will put pressure on prices. This implies there is still a role for interest rates.Next, RBI takes on the issue of fiscal consolidation. It does not believe that the fiscal target will be met, unlike the PMEAC which has stuck to the 5.1% target for the year. The economic slowdown will affect revenue; and by its own calculation feels that by not taking action on fuel prices, the subsidy bill by itself could swell by 0.4% of GDP, meaning thereby a slippage of around R40,000 crore or the doubling of the budgeted amount. This is based on the twin developments of oil price moving up, which has already happened, and the hesitancy in increasing administered prices of fuel products, which would inflate the subsidy bill. This is serious stuff because it means that the deficit would be at least 5.5% of GDP, to which one must add the revenue slippages on tax as well as disinvestment and spectrum auctions. It has hinted at expenditure switching from cutting revenue expenditure to capital—a theoretical and not practical possibility, given today’s conditions.RBI is also less confident on the external front. The current account deficit, while benefiting marginally from the lower commodity prices, would be under pressure on services and there has to be considerable support from the capital account. Here, RBI warns of not using the debt route, which was popular earlier on account of the ECB cost that was attractive. This will lead to issues of debt sustainability and hence we have to look at FDI. Here again, there is a question raised on the policy front because under depressed global economic conditions, one cannot elevate these flows without affirmative action on policies.With an overall warning being given by RBI on all ends, what is one to make of it? The first is that growth will not be higher than 6.5% and there is a chance of a downward revision by RBI if things do not improve. The drought and its impact will be a reason for such downward revision.Second, there appears to be an exhortation from RBI to the government to mend the fences in terms of both fiscal consolidation and policy movement. It has very subtly mentioned that the government had promised to take steps in early August, which, if taken, can improve economic conditions. Would this be a cure for the present ailment? This is debatable because while policies would work in the medium run, they would only improve sentiment in the short run. Can the government really bring about the policy changes that we are talking of? Some of the issues can be dealt with and would probably be taken up with urgency, given that the FM has also spoken of moving the economy along. But, in the immediate run, this could probably only mean that we would be within this range of growth and not slip badly.Third, RBI has also quite clearly stated that there is limited space for monetary policy action, which can be taken to mean that we should not be expecting anything dramatic from RBI in terms of rate cuts, given the severity of inflation, where there is also excess spending taking place. It has also been silent on measures to improve corporate investment and focused more on improving infrastructure investment—another indication that India Inc should not expect significant rate cuts this year.

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