Budget has placed RBI in a SPOT

Chances of a further increase in inflation in the background of the Budget proposals cannot be ruled out. Expecting the Reserve Bank to cut policy rates will amount to sacrificing price stability for economic growth.

March 25, 2012:
The Budget for 2012-13, after assessing the results of the elections in five States, has a slew of measures intended more for the Government's survival than reviving the sagging economy.

As against 6.9 per cent GDP growth finally estimated for the current financial year (2011-12), it has projected growth for the coming fiscal at a moderate 7.6 per cent with scope for 0.25 percentage points deviation either way.

Pursuing safe policies

The undertone of the Budget is good, revealing the Government's awareness about the urgent need to give a boost to the economy through bold reform policies.

But for certain obvious political compulsions, it seems to have decided to pursue safe policies leaving the economy to take its own course.

That the Budget is not the only exercise to remedy the ills plaguing the economy is the message being conveyed by the Government.

Nevertheless, it has attempted to please all key segments of the economy — agriculture, industry, infrastructure, particularly power, the capital market, small and medium enterprises, and the salaried class.

Perhaps, the services sector is the only exception, with more services being brought into the tax net and enhancing the tax rate from 10 per cent to 12 per cent.

The approach of the Government, no doubt, is positive but needs to be closely monitored for successful implementation, especially the measures intended to bring down subsidies to 2 per cent of GDP and contain the fiscal deficit at 5.1 per cent of GDP.

The fiscal and current account deficits continue to remain high and this could worsen and add to the inflationary pressure.

The current prices of crude oil, at around $125 a barrel, and the exchange rates are not very favourable.

The $115/barrel taken by the Government for its assessment of fiscal deficit and the oil subsidies not actually provided for can lead to the deficits slipping further.

In case oil prices come down, as has happened in the past, it can only be a bonus.

Rate cut expectations
The Reserve Bank's recent monetary policy measures, which include cutting the CRR (cash reserve ratio) by 1.25 percentage points in two instalments, keeping the repo and reverse repo rates unchanged at 8.5 per cent and 7.5 per cent, respectively, and the marginal standing facility at 9.5 per cent, have had a softening effect in the money market and generated further expectations of policy rate cuts.

However, with higher excise duty on a wide range of items, increased charges on a large number of services hitherto not covered, exchange rate fluctuations, with the rupee hovering around Rs 50 to a dollar, coupled with uncertainties in the international markets, the expectation that inflation can be brought under control seems like wishful thinking.

The increase in rail passenger and freight charges will also have an adverse impact on commodity prices.

The realities are, therefore, far from expectations. The Wholesale Price Index-based inflation, which was 6.6 per cent in January 2012, increased to 7 per cent in February. Retail inflation, based on Consumer Price Index, has risen from 7.7 per cent to 8.8 per cent.

The retail inflation for rural and urban areas worked out to 8.4 per cent and 9.5 per cent in February as against 7.3 per cent and 8.3 per cent, respectively, in January.

Chances of a further increase in inflation in the background of the recent the Budget proposals cannot be ruled out.

Expecting the Reserve Bank to cut policy rates will only amount to sacrificing price stability for economic growth, which is elusive due to several other factors other than interest rates and are beyond the control of the apex bank.

‘Fiscal consolidation'

The RBI has been repeatedly cautioning the Government that “credible fiscal consolidation will be an important factor in shaping the inflation outlook.”

As the situation has not changed much, it will be too early for the Reserve Bank to take a realistic view on the policy rates in its April review.

In fact, the Budget has put the Reserve Bank in a tight spot. The achievement of the twin objectives of monetary policy — economic growth and price stability, which includes financial stability — has been rendered an uphill task.

Dr.T.V.Gopalakrishnan

(The author is a Mumbai-based consultant. The views are personal.)

(This appeared in The Hindu BusinessLine dated 26/03/12).