Credit policy: Are Government, RBI on the same page?

Credit policy: Are Government, RBI on the same page?

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New York: 


  1. The government and RBI have agreed on rate cuts to stimulate growth. Or have they?

A surprise cut in repo rate announced by Reserve Bank of India pleased everyone. The BSE Sensex rose 1.2 per cent on Tuesday virtually expressing gratitude as the rate cut should bring some temporary relief to businesses hurt by a persistent hike in interest rates. 


The government wants growth at all cost. RBI has said today that it would do its bit to help. There are all smiles everywhere. 


However, governor D Subbarao's policy statement reads more like a warning letter to the government than an effort to stimulate growth. He is clearly not convinced that the government would deliver on promises that it has made on fiscal consolidation or even on supply-side infrastructure that could help curb inflation. 


Ahead of the credit policy announcement, finance minister Pranab Mukherjee announced that the credit policy should signal a reversal of the interest rate policy.  He was addressing the annual general meeting of the Confederation of Indian Industry or CII, the industry body in New Delhi.


Such a statement by the country’s finance minister ahead of the policy announcement is strange.


Was he worried that RBI may not cut enough or not cut rates at all?


"I know that there are some concerns about the fiscal deficit target for the current financial year. Let me assure you that the budgetary exercise has been done with due diligence and I would do my best to restrict the government expenditure to the budgeted figures,” Mukherjee said at the CII event.


There are reasons for RBI to be concerned. RBI's monetary statement criticises the government on deficits and subsidies. Analysts and economists doubt the government's ability to deliver on reforms to stimulate growth.


Here are some other points:


• RBI criticizes deficits: If RBI governor D Subbarao has taken a differing view, he is right in taking such a view. The government has shown no signs of austerity to control its expenses. The government plans to meet 65% of its full-year borrowing target in six months, clearly indicating that it has no plans to cut expenditure. RBI has said that the government deficit level was highly unsustainable. “The yield on the benchmark 10-year government bond hardened again somewhat towards end of March 2012 reflecting concerns about government borrowing programme in 2012-13 which is significantly larger than even the expanded programme of 2011-12,” RBI said in its credit policy statement. It has yet again called for fiscal consolidation.


• RBI wants subsidies cut: RBI has also criticized inadequate steps taken by the government to cut subsidies. It has warned that the government’s inability to cut expenditure reduces space to cut rates to stimulate growth. “Persistent demand pressures emerging from inadequate steps to contain subsidies as indicated in the recent Union Budget will further reduce whatever space there,” RBI said in its guidance. Going forward, the government has to focus on cutting fuel and fertilizer subsidies to achieve the fiscal deficit target of 5.1 per cent of GDP.


• Acceleration of reforms: The ball is now in the centre’s court to take steps to stimulate growth. India needs new investment into infrastructure and other sectors. Monetary stimulus alone cannot push up growth. According to a RBI working paper on foreign direct investment for 2010, the overall FDI remained stagnant during that calendar year but fell 34 per cent for India. This clearly shows that the country is increasingly getting unattractive. The government needs to take steps to push for direct and indirect tax reforms through implementation of the Direct Tax Code and Goods and Services Tax. It also needs to take concrete steps to make India friendly once again for FDI.


• Inflation to stay high: RBI’s stated enemy number one is inflation. RBI has chosen to make this sharp cut in repo rates up front but has given sufficient indications that inflation is still a worry. Rise in international oil prices and increase in the consumption of protein rich food items pose a threat. The RBI expects the government to ease supply side pressure to curb potential rise in food inflation going forward.

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