The perceived difference of opinion between the Finance Minister and the Reserve Bank of India (RBI) Governor appears to be out in the open. If true, it is an indication of the frustration both sides feel since we do not appear to have made progress either on growth or tackling inflation.
The ministry and the central bank have been tossing the ball into each other’s courts—and both have been taking some actions—but interest rates do not look like coming down fast enough to lift growth sentiments. How exactly do we deal with this situation?
The FM, along with other ministries, has taken certain decisions in the last couple of months or so to resuscitate the economy. However, while the steps are progressive, a closer look suggests that few of them will actually provide an impetus to growth in the short run.
FDI in insurance and pensions have to go through Parliament. FDI in retail is optional for states and will take a couple of years to materialise. Fuel subsidy rationalisation has begun, which will contain the subsidy bill and the deficit, but the future remains uncertain.
Disinvestment and spectrum sales, though strong points in the recent statements of the FM, may not bring in the needed moolah in the four months left in this fiscal year.
As for the measures on withholding tax and external borrowings, these bring clarity to the parties concerned and on retrospective taxation, but these are not game-changers.
All these steps will help improve business sentiment and may not actually add to growth this year. We need Keynesian spending, but we do not have the money. The FM has spoken of controlling expenditure and, given that there will be no compromise on anti-poverty programmes, one can see cuts taking place in project expenditure.
Therefore, what the government has done is work towards containing the deficit and improving the investment climate, but there are no concrete steps to push growth. Therefore, in a way, the journey along the ‘lonely’ path has not really begun.
The RBI has carried out studies to show that higher interest rates do not come in the way of growth. This has been reiterated by the Governor, who has averred that inflation, demand, and fiscal consolidation are more important issues. Therefore, there is concentration on inflation and as long as it is high, consumers spend more on food and necessities, leaving less of a surplus to spend on other goods which can impact production and growth.
Now, the RBI has maintained that as long as there is fiscal disarray, it cannot do much. At the same time monetary policies have linked interest rates with inflation—food, core or retail. Does fiscal slippage make it harder for the financial system? In the present situation, higher deficits have been tackled with a lot of support from the RBI through open market operations to ensure that the private sector is not crowded out of the credit markets.
Last year, around Rs 1.4 lakh crore, was injected while this year Rs 87,000 crore has been supplied to the system besides the CRR (cash reserve ratio) cuts. Therefore, this theory does not really hold. Besides, if the government is maintaining that the fiscal slippage will be marginal this year, then the RBI need not have to worry about this issue.