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RBI may have to recast monetary policy

The recent developments in the forex, money and stock markets suggest that the UPA Government and monetary authorities would have to recast their strategy and reformulate the fiscal and monetary policies for ensuring balanced economic growth with the gross domestic product (GDP) rising by 9-10 per cent.

The heady forex inflows so far in the current financial year resulting in an addition of $ 62 billion in foreign exchange assets against $ 46.8 billion in the whole of 2006-07 has resulted in a steady appreciation of the rupee by 12.6 per cent vis-À-vis the dollar since the end of October last year.

This increase in the external parity of the Indian currency is due more to technical factors rather than improved competitive ability of the industrial and agricultural sectors of the economy.

However, the impact of dearer rupee on select basic industries, which account for 40 per cent of total exports, has been such that Kamal Nath, Union Minister for Commerce and Industry has, for the first time, expressed serious apprehension about these industries being compelled to reduce exports sizably.

It has been indicated that exports of textiles declined by 22 per cent, handicrafts 66 per cent, leather 9 per cent and marine products 20 per cent in April-October 2007. The shortfall under these heads have to be overcome with a step up in shipments of other items which are in peak demand in overseas markets. But the industries adversely affected by dearer rupee account for employment of millions of workers and it is imperative that their competitive ability should not be impaired unduly till such time new measures yield the desired results.

The increase in exports up to September was only 18 per cent against 27.1 per cent in the corresponding period in 2006-07.

The spurt in exports by 35.65 per cent in October may prove to be a flash in the pan as the ministry’s spokesman has observed that forex earnings in 12 months may be only around $ 140-150 billion and the target of $ 160 billion may be difficult of achievement.

As imports also will be increasing noticeably with larger outgo in respect of oil and non-oil imports, the trade gap may widen uncomfortably in 2007-08 and the current account deficit may be higher at $ 13-14 billion against $ 9.6 billion in 2006-07. This gap may be bridged as on former occasions with heavy forex inflows on capital account. Even though it may be argued that the future prospects are promising and there may not be deficit on current account after 2008-09, the monetary authorities have been obliged to intervene in the forex market and effect sizable purchases of U.S. dollars. The substantial purchase has resulted in disturbing increase in money supply and it has been necessary to hike the cash reserve ratio by half a percentage point to 7 per cent effective from August 4 and also intensify market stabilisation operations.

These measures have not been quite fruitful. While there has been a surge in the growth of deposits, credit expansion has slowed down significantly due to prevalence of higher lending rates and cost escalation in some directions.

While the industries turning out capital goods, communication equipment, electronic and electrical components have been maximising their output, the average rise in industrial output was 9.2 per cent in April-September against 11.1 per cent comparably.

The slower rise in industrial output cannot be allowed to persist even though it may be claimed from the national angle that the growth in the GDP may be even 9.2 per cent because of the better performance of the agricultural sector.

Sharath Pawar, Union Minister for Agriculture, has stated that there will not be any further increase in wheat imports in the coming months apart from the commitment to secure one million tonnes for bolstering buffer stocks.

With steady open market prices for rice and a noticeable downtrend in prices for wheat and pulses, the monetary authorities have to worry only about the effects of upward adjustments in respect of the petroleum sector if world prices for crude fluctuate around $ 90 per barrel. As the UPA Government and the Reserve Bank of India can now expect that there will be an abatement of new inflationary pressures, it has become necessary to stimulate industrial growth in some directions. Towards this end, the Governor of the Reserve Bank should take a decision about a reduction in interest rates even by controlling an uncomfortable rise in money supply. Selective credit expansion on a cheaper basis will have to be attempted if the slowdown in industrial output is to be reversed.

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