ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Need for Fresh Ideas and Risk-Taking

Uncertain Economic Backdrop UNCERTAINTIES in the real economy continue to bedevil the operations of the financial markets. All the three key factors responsible for the industrial slowdown in the first place, namely, reduced public expenditure, slackness in credit supply and high real rate of interest, show no sign of easing, not at any rate to the extent required. Added to them is the deepening of global recession which is keeping the export sector depressed. The hopes generated by the injection of nearly Rs 18,000 crore of liquidity into the system through the Resurgent India Bonds (RIBs), as also the promises of increased public expenditures and improved credit delivery, seem to have got stuck in structural and bureaucratic bottlenecks.

Expectations of Economic Revival

The Backdrop THOUGH the financial markets seem to signal positive expectations, it is as yet difficult to discern them in any physical indicators of economic activity essentially for want of more recent data. The mobilisation of $ 4.16 billion (over Rs 18,000 crore) through the Resurgent India Bonds (RIBs). combined with a normal rainfall situation and the government's promise of higher expenditure programmes for stimulating investment demand for capital goods, automobiles' steel and other construction materials, seems to hold out hope for improved industrial activity in the second half of the current fiscal year. The commercial sector, which faced an acute shortage of demand for goods and services and hence a severe liquidity stringency now for about two years, seems hopeful of seeing some respite from both these constraintsThe policy impulses emanating from the finance ministry for increased public expenditures and those from the Reserve Bank of India for improving credit delivery appear to reinforce these expectations.

Creeping Stagflation

For the third successive fiscal year, industrial growth remains low. On the other hand, the annual inflation rate has distinctly picked up. Against this backdrop of creeping stagflation, the fiscal and monetary scene is such as to give cause for grave disquiet.

Shedding Monetarist Blinkers

The Reserve Bank is shedding its erstwhile monetarist blinkers and this has enhanced the credibility of its efforts to curb speculation and excessive volatility in the short-term money and foreign exchange markets.

High Cost of Fiscal Mismanagement

Budget and Money Market THERE arc several proposals in the central budget for 1998-99 which will have implications for the financial markets, the most significant amongst them being the proposed fiscal deficit and the means of financing it, In this context, it may be mentioned in passing that the financial markets would be by now nursing substantial scepticism about the government's ability to rein in fiscal deficit as professed in initial budgetary projections. The last year's slippage in gross fiscal deficit from the budgeted 4.5 per cent of GDP 10 the actual of about 6.1 per cent was not a unique one; it has been happening now almost continuously during the past five years, essentially because the fiscal reforms have taken the path of a narrow construct based on a mainstream stabilisation and structural adjustment programme, without an integrated long-term strategy of resource mobilisation (by assigning appropriate roles for direct and indirect taxes and protection rates on export- import trade), restructuring of public expenditures, comprehensive reforms of public sector enterprises and sustainable levels of domestic and foreign borrowings. The rash populist measures taken so far on an all round slashing of direct tax rates and haphazard reductions in indirect tax rates have made it impossible for the government to achieve any semblance of fiscal balance. The budget for 1998-99 has placed the fiscal deficit at 5.6 per cent of GDP which is only marginally lower compared to 6.1 per cent in the previous year. In absolute terms, the gross fiscal deficit proposed at Rs 91,025 crore for 1998-99 stands at 36.4 per cent higher than what it was two years before, namely, Rs 66,733 crore in 1996-97, though it is only 5.4 per cent higher that in 1997- 98 (Rs 86,345 crore), Apart from very many complex issues, a danger inherent in the expansionary fiscal stance of the 1998-99 budget without the supporting real resources is the near certainty of revenues falling behind the targets and expenditures outstripping the targets, thus giving rise to further stretching of the borrowing needs. As it is, the borrowing programme set out in the budget can only be called massive: Rs 48,326 crore in net terms and Rs 79,376 crore in gross terms as against Rs 40,494 crore and Rs 59,637 crore, respectively, in the previous year. What is more worrisome is that net borrowings through medium and long-term securities (including market borrowings), i e, other than 364-day TBs, are budgeted to rise by Rs 23,443 crore or by 77 per cent from Rs 32,488 crore to Rs 55,931 crore. The higher borrowing programme and the persistence of borrowings from the RBI through large subscriptions to market borrowings as well as ways and means advances are sure to have serious implications for interest rates, as also for monetary and general economic stability.

Macro Perspective A Refreshing Change

Monetary and Credit Policy THE latest monetary and credit policy announced by the RBI on April 29 in respect of the first half of 1998-99 seeks to make a significant, even if guarded, departure from the earlier policy stance. To begin with, there is the noteworthy admission that the analytical framework underlying monetary policy hitherto, which has accepted the stability of the money demand functions as its cornerstone, requires rethinking. Though the RBI governor's statement singles out recent financial innovations as the cause for this reconsideration, sufficiently strong reasons for adopting an eclectic approach to the formulation of monetary and credit policies as suggested now had already existed. The bi-directional nature of the relationship between money, output and prices had been long recognised and the monetary character of inflation ingrained in the existing framework questioned. The influence of the level and structure of interest rates on money demand has been a proven factor now for over two decades. "A striking aspect of credit policy in 1974-75 was the emergence of interest rate as an important instrument of monetary management"; so had said the RBl's Annual Report for that year, more than 20 years ago. Despite the interest rate weapon being effectively deployed from time to time, its use in the RBl's thinking on policy framework has generally fallen by the wayside during the past decade or so, essentially because of the dominating influence of monetarism. Such a blinkered approach to monetary policy formulation hitherto had prevented the authorities from seeking a more positive role for money and credit in the development process. Therefore, the promise now made by the RBI governor to look for a wider set of indicators from the domestic financial and foreign exchange markets, including credit movements, juxtaposed with output and other real sector data, should open up a new and welcome path. A second refreshing change is seen in the importance given to institutional and structural features of the financial system rather than the focus being on such broad macro numbers as M1 and reserve money and their relationships. That such a fresh thinking was in the offing was evident from the appointment of three committees by the new RBI governor immediately on taking charge-two one-man committees for studying credit delivery inagriculture(R V Gupta) and small-scale industries (S L Kapur) and a working group of chairmen of commercial banks and development finance institutions(DFIs) under the IDBI chairman S H Khan on harmonising the regulatory environment for banks and DFIs. The observations contained in the RBl's credit policy statement in respect of these areas - though not many policy decisions have been formulated as yet bring out the freshness of thinking that is being brought to bear on the whole financial sector policies; the proposed reforms in the financial sector are being carefully crafted. For instance, the preference expressed by the authorities hitherto has been to rapidly move towards the concept of Universal banking' and abolition of the distinction between banks and DFIs. But the RBI governor's latest policy statement puts forth significant words of caution and promises a ''discussion paper" setting out the RBI's draft proposals "for bringing about greater clarity in the respective roles of banks and financial institutions and for greater harmonisation of facilities and obligations applicable to them". In the case of institutional credit for agriculture, the emphasis would be on simplification of delivery mechanism and a substantial reduction in paper work, The question of strengthening of institutions for rural credit, which is a crying need of the hour, remains however to be addressed.

Ample Liquidity, but No Pick-Up in Investment

in Investment The financial markets were marked by an abundance of liquidity throughout 1997-98, even though funds deployed by banks in non-food advances and commercial investments picked up in the latter half of the year. So did disbursements by the term-financing institutions. The injection of liquidity seems, however, to be getting absorbed in higher inventories and, on the supply side, in substitution of capital market funds, Effective investment in the economy, in manufacturing and infrastructure in particular, does not appear to be picking up.

Fiscal Impetus Missing

Fiscal Impetus Missing The economy is facing a serious structural constraint Public sector investment, which crowds-in private sector output and investment, has suffered badly. Private sector companies are not in a position to raise fresh equity as the share market is in the doldrums. Fear of non- performing assets and capital adequacy requirements is hindering banks and financial institutions in extending credit to industry. In such a situation, decisive action on the fiscal front alone can break the impasse.

Fire-Fighting on Policy Front

Fire-Fighting on Policy Front Instead of operating on their long-term policy mandates, apex institutions such as the RBI SEBl and IDBI seem to concentrate on immediate, short-term issues. This distortion of the perspective of policy-making is embedded in the type of liberalisation of the financial sector and the foreign exchange market that has taken place.

Reversal of Premature Policies

Reversal of Premature Policies Developments in the domestic financial markets against the backdrop of the turmoil in the south-east Asian markets have punctured the claims of the authorities that India's economic fundamentals were satisfactory and that we could open up the external sector further leading soon even to capital account convertibility. Therefore, if the new governor of the Reserve Bank has been introducing measures retracing some of the steps earlier taken prematurely and not as a natural consequence of sound fundamentals, he has strong reasons for doing so.

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