Some plain speak on policy

By S. Swaminathan

The ``Report on Currency and Finance 1998-99'' unveiled by the Reserve Bank of India on Thursday maintains the sturdy traditions of independent counselling of the Government by a state-owned central bank. Barring puritan theorists who revel in arcane controversies about the autonomy of the RBI, analysts of the interface between monetary and fiscal policy in India, over the years, have almost uniformly been impressed by the mutual vibrations between the monetary authority and the Government.

While in the pre-1991 period, the general tenor of the annual reports on currency and finance was one of plaintive concern on the part of the RBI, over the deterioration in fiscal discipline of the Government, the RBI has in more recent years shifted gears in favour of prevention of the Government from taking the central bank for granted in the matter of ways and means advances. The elimination of automatic monetisation of fiscal deficit through the discontinuation of the practice of issuance of ad hoc treasury bills was indeed a crucial reform put through during the stewardship of the RBI by Dr. C. Rangarajan. That this step has not resulted in any firm reversal of the trend for the gross fiscal deficit to overshoot official estimates, year after year, is but a confirmation that fiscal policy continues to be a captive of the ``soft state'' where it relates to non-development expenditure.

Structural blocks in fiscal correction

The Report on Currency and Finance 1998-99 brings some semantic innovation to the debate on fiscal correction. The overall fiscal deficit, according to the RBI, consists of two components - the cyclical and the structural factors. While the first component has a lot to do with the dynamics of the economy and with the growth of the GDP, the latter broadly encompasses the relative inflexibility of expenditure (administration, interest charges and subsidies) and the stickiness in revenue generation, as evidenced by the stagnation (or decline?) in tax revenue as a percentage of the GDP.

All this is not a startling revelation. But what is instructive in the new dissection of fiscal deficit is that the Government cannot hope to solve the impasse on the fiscal front except through the reduction of the public debt (thereby bringing down the interest commitments) and the augmentation of tax revenue through a determined course of taxation of the services sector which now accounts for almost 48 per cent of the GDP.

The RBI has brought up the question of disinvestment not as a far-fetched fiscal antidote to the snowballing of public debt but as a strategic withdrawal of the Government from areas of activity which do not constitute its core competencies. The manner in which the RBI has posed this issue gives reasonable grounds for optimism that a clear re-engineering of Government for more effective action on infrastructural development and larger public investments in education and health and for the provision for basic amenities for the poor would become feasible. But on the need for widening the tax base by bringing in agriculture and the services sector, the inherited political culture of undue solicitude for the farming community and sheer cowardice vis-a-vis a strongly organised group of service- providers (the truckers, for example) need to be overcome. It is for the RBI to offer its sage counsel. Will the political establishment take up the gauntlet?

The exchange rate for whose comfort?

The RBI has indeed done well to disabuse large sections of the export community of the abject supposition that the role of the RBI in management of the exchange rate for the rupee is that of keeping the currency at as low a level in relation to the U.S. dollar as would impart competitive strength to Indian exports (through lower international prices). Far from saying that large inflows of foreign capital could result in an appreciation of the rupee, the RBI has pointed out that exchange intervention would be necessary in such a contingency even though the inflationary consequences of monetary expansion could hurt the competitiveness of Indian exports. In the ultimate analysis, the strengthening of the external sector would depend on export growth based on cost competitiveness and international marketing strategy which responds quickly to changing tastes and preferences in the global markets.

The perspective on interest rate

With inflation rates hovering over 2.5 per cent (as measured by the WPI), questions have been raised as to why the RBI has not asserted itself in favour of a reduction in interest rates in the system.

On the face of it, the position that the RBI has taken, namely that in a regime of deregulated interest rates, it is for the commercial banks to take the initiative in reducing their lending rates, is unexceptionable. But the rider in the RBI postulation is that most banks cannot afford to reduce their lending rates, given their own structural rigidities (as evidenced by the wide margins they need to keep themselves in a state of profitability) apart from deposit rates which cannot be brought down without the risk of a decline in their rate of growth. But in the Report on Currency and Finance now released, the RBI appears to be seriously concerned with what might be called, ``a secular stagnation'' in bank deposits. Nor is this all.

The RBI report speaks of a decline in the relative importance of the banking sector in resource mobilisation for the commercial community. For one thing, the corporate sector seems to be weaning itself away from reliance on high-cost bank credit and moving towards equity finance, both domestic and external. For another, the phenomenon of non-performing assets (NPAs) largely related to mandated lending to the priority sector, seems to be compelling banks to adopt ``prudent'' (or rather prohibitive) standards in new project appraisals. This in addition to the fear psychosis created by the ``vigilance system'', is perhaps operating against substantial new lending by the banks. All this would explain why banks are becoming increasingly redundant, at any rate, for large and medium-sized corporates. On what could be the way out of structural debilities in the banking system, there is alas no new wisdom in the RBI report!

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