Will Subbarao oblige Mukherjee?

March 28, 2012

(The views expressed in this column are the author’s own and do not represent those of Reuters)

“The government will be forced to take difficult decisions,” Finance Minister Pranab Mukherjee said at a FICCI event while expressing hope of a “reversal of the policy rate which should help in improving business sentiments”.

RBI Governor Duvvuri Subbarao has his own assessment of a rate cut.

On March 15, the day before the budget was presented to parliament, the RBI had its quarterly review but it passed without any change in monetary policy. Only a week before, the RBI had reduced the CRR by 75 bps to supplement liquidity which had dried up. But the repo rate was held steady.

The repo rate had been stepped up to combat inflation since March 2010 by 375 bps in thirteen instalments. Inflation, however, did not budge until November 2011 when there was a larger supply of agricultural commodities, particularly vegetables. Food prices had dropped and headline inflation was down to 6.1 percent — only to recover to 6.9 percent in February.

The reduction in CRR put 450 billion rupees in the banks’ kitty. This money, on which the banks did not earn any interest, was available to be loaned or invested. In response, the banks could have reduced the interest on credit.

The finance ministry had therefore been persuading the banks to lower interest and the State Bank of India agreed to do that selectively.

The huge increase in the rate of interest, though it did not calm inflation, certainly killed investment. From 3.3 trillion rupees in the first quarter, investment in projects declined to 1.9 trillion rupees in the third. Many projects became unviable and investments of over 3.5 trillion rupees had to be shelved. Unless investment revives, GDP growth will not pick up.

The finance minister did not provide any investment-linked incentives in the budget to pep up growth. On the contrary, he went in for huge additional taxation amounting to 414 billion rupees. Mr Mukherjee has therefore to rely on Mr Subbarao to turn the economy around and save the budget from getting into a mess, even if he succeeds in taking ‘difficult decisions’.

That is because the reduction in expenditure from ‘difficult decisions’ is already accounted for with a cut in subsidies amounting to 0.4 percent of GDP. What is critical is the revenue from taxation which will materialise only if the economy grows 7.6 percent as anticipated. And that is possible if the repo rate is cut expeditiously.

Two questions are relevant. First, when should the repo rate be reduced? And second, what should be the extent of reduction in the repo rate? Going by the experience of 2008-09 when the economy was in a similar position, a quick reversal of GDP growth became possible because the repo rate was reduced from 9 percent to 4.75 percent in just a few months.

The RBI has to move that fast now to get the economy back on the rails to achieve 7.6 percent growth. But will Mr Duvvuri Subbarao oblige Mr Pranab Mukherjee?

One comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

I would be surprised if he bows down to political/popular pressure – inflation figures shown are very misleading, I don’t understand why is it WPI instead of CPI and also I personally seen how much things have gone up in India being here from 2003-2005 the 2009-2010 and now 2012. Empirical evidence would highlight that inflation is a lot more then what is reflected in the numbers coupled with the invariable need for the government to allow free price movement in Oil/Petrol products which are heavily subsidised and causing severe fiscal strains for the govt (Indian Oil Marketing Companies losing well over Rs 500 Cr – $100 Mn a day by selling cheaper petrol/diesel prices).

Lot of the financial gurus of the world have applauded Duvvuri Subbarao and RBI as one of the best and sound Central Banks in the world that whole image would in my opinion go out the window if he would oblige to cut Repo rates this year but tomorrow is not the day another 1 Max 2 quarters.

Ultimate test of character tomorrow!

Posted by KaranKC | Report as abusive