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Monetary policy assumes new significance

The stock market surged ahead last week ignoring the fact that it tumbled furiously on the budget day (July 6). Though the market expectations run up to the budget were belied, the accompanied statements from government quarters later gave a stimuli to the market sentiment.

The stock indices, which nosedived on the budget day by 869.65 points or 5.83 per cent on the Bombay Stock Exchange and on the National Stock Exchange by 258.55 points, recovered as the government reaffirmed its commitment on stock sale in public sector enterprises (PSEs) and other reforms.

The government was clear that `aam aadmi' was at the centre of its focus in the wake of the economic uncertainties owing to the impact of global financial crisis. However, the government made it also clear there would be no deviation from the process of reforms which would be carried forward.

While stressing welfare and inclusive growth, Finance Minister Pranab Mukherjee proposed a large portion of budget allocation for agriculture, education and rural and urban development, crossing the Rs. 10 lakh croremark on budget expenditure for the first time.

The ensuing fiscal deficit of 6.8 per cent of GDP (Rs. 4.51 lakh crore) in 2009-10 would be the contentious issue while the Lok Sabha and the Rajya Sabha pass the budget in the last week of this month.

As the government borrowing would go up there was a hue and cry from certain quarters that the private sector would be deprived of funds. However, the Finance Minister affirmed that with the economy showing signs of recovery, the government had to go in for increased borrowing for a higher growth in the absence of private investments. Currently, the private sector was not so keen to make large investments in projects, Mr. Mukherjee said while replying to the debate on the budget in the Lok Sabha.

"While monetary policy has a clear and distinct function in overall economic policy, it has to recognise the over arching role of fiscal policy," says S. S. Tarapore, former Deputy Governor of the Reserve Bank of India. According to him, the immediate challenge to monetary policy is to deal with the fallout of fiscal policy imperatives which have resulted in a huge gross fiscal deficit. "This would put an immense pressure on resources."

"This is the single most important feature against which the current monetary policy has to be framed. An overriding objective of public policy is that the quantum jump in government borrowing be undertaken without any increase in the present low interest rates on government securities; in fact, the official preference is for even lower interest rates. Furthermore, there is the policy imperative of providing substantially larger credit to the commercial sector at lower and lower rates of interest," Mr. Trapore stated while presenting a paper on monetary policy and financial sector reforms at the 20th Skoch summit 2009 on "inclusive growth".

For the immediate future, the RBI stance should be to clearly cry halt to the policy signals of the past nine months of lower interest rates, Mr. Tarapore points out.

While political economy considerations may prevent the RBI from giving an unequivocal signal of monetary tightening, by raising the repo rate, it certainly should not reduce the present repo rate of 4.75 per cent and the reverse repo facility at 3.25 per cent and give up the concept of a corridor.

Like interest rates, says Mr. Tarapore, the time has come to no longer talk about possible reduction in the 5 per cent Cash Reserve Ratio (CRR) but give a clear signal that the CRR may need to be raised in the near future.

"The over arching priority of the Union budget of 2009- 10 is growth, which takes precedence over fiscal containment," said Ashok Chawla, Finance Secretary, Ministry of Finance, in a post budget Interactive session organized by the Confederation of Indian Industry (CII).

Mr. Chawla pointed out that inspite of the huge spending that the government will incur as per the budget estimates wherein approximately 40 per cent of the expenditure is funded by borrowings of 4 lakh crores, the fiscal deficit will also be contained in a phased manner. He reiterated that the current deficit of 6.8 per cent of GDP is hoped to be reduced by 1.5 per cent every year. The Finance Secretary also assured that disinvestment of share holding of PSEs will take place in a systematic manner.

RBI Deputy Governor Shyamala Gopinath also reportedly stated that: "We would be managing this (borrowing) programme in a nondisruptive manner. There is ample liquidity in the system". "It is disconcerting that senior policy makers in the government have gone on record to say that the RBI should, through open market operation, pick up 50 per cent of the borrowing programme," says Mr. Tarapore. Such a policy response by the RBI would have serious adverse repercussions. Such a large borrowing programme can be put through only by raising interest rates or a large increase in created money resulting in unbridled monetary expansion. "Emphasising this would put an end to the clamour for lower lending and deposit rates."

Prime Minister Manmohan Singh in his earlier stint as RBI Governor said that, "the Governor RBI has the loneliest job in the country.'' D. Subbarao may find himself too lonely in the interregnum period.

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