Originally Published 2013-12-20 11:44:27 Published on Dec 20, 2013
The government is perhaps keen on projecting a welfare-oriented profile in which the poor are looked after. Prices, jobs, higher industrial growth and prospects of rapid economic recovery will remain the most important planks on which the next elections will be fought. The RBI's latest move of not raising the repo rate may also help in economic recovery.
RBI surprises all by not further raising the repo rate
" The blame game has started after the defeat of the Congress party in the recent assembly elections in four states. Many have blamed the weak state of the economy and rising inflation for the Congress defeat. Inflation has been a burning issue for long and has affected all, especially people with fixed incomes and those in the low and middle income brackets. After the elections there has been another 'triple whammy' which is a spurt in retail (Consumer Price Index) inflation which reached a high of 11.24 per cent in November. Annual food inflation was at 14.72 per cent and the Wholesale Price Index was at a new 14-month high of 7.5 per cent. Industrial growth, on the other hand, contracted by 1.8 per cent in October.

The data show that the country is facing a serious crisis of high inflation and industrial slowdown--something which needs to be addressed immediately. The negative industrial growth is a shocker because in October, industrial growth was 2 per cent, which was interpreted as a sign of reversal of a declining trend and industrial recovery. The question is: what should the government do next? Another repo rate rise by the Reserve Bank of India seemed imminent and was factored in by the market.

In fact, RBI Governor Raghuram Rajan raised the repo rates twice (which led to higher lending rates) since he took over in September 2013 to rein in inflation but this did not have much impact. On December 18 he surprised all by not raising the repo rates any further. He said he was waiting for further data on inflation and banking on food inflation coming down. Food inflation came down a few notches recently due to a better supply of vegetables in the market but this could be temporary. In general, the overall high prices have stubbornly remained a part of the economic landscape. One can trace this phenomenon back to the global financial crisis when in order to avoid any impact of the crisis the government gave two big stimulus packages to revive the economy and demand. This it created an unprecedented budgetary deficit and the fiscal deficit rose to 6.5 per cent. There was too much liquidity in the economy and prices started to rise and even though the government tried to control it by raising interest rates 13 times, inflation remained high. The inflationary expectations are also building up which means industrialists are reluctant to invest and are holding on to their money. Investment is at a low point also because of the high interest rates. There has been a virtual famine of fresh investment in industry and even real estate.

Investment decisions have been postponed for other reasons also and one of them is political uncertainty. People are waiting for the government to change and the new government to make its policies clear. The rupee's value keeps fluctuating which has created uncertainty and foreign investors are cautious.

On the positive side, exports did rise as a result of the fall of the rupee but in November, they showed only 5.9 per cent growth. The forex reserves have risen to $291 billion. The FIIs are investing once again in the emerging markets, including India. The current account deficit has shrunk-more because of a compression of imports than through the rise in exports, and it would not put pressure on the rupee.

Yet there are dangers of the FIIs going out again with the slow and steady recovery in the US economy and the much talked-about tapering off the monetary easing policy by the Federal Reserve will start in January 2014. This may lead to FIIs turning back to the US and there could be a dollar shortage and the rupee could fall further. The rupee's fall could also be triggered by demand from the corporate sector to pay off bunched-up debts.

Regarding industrial growth, the problem has been a slowdown in demand, especially in consumer goods which grew only at 5.1 per cent in October 2013. The good monsoon this year, however, is leading to higher demand for consumer goods and durables, especially in the rural areas, but this is getting mitigated by the slow growth in demand in the urban areas due to inflation.

On the whole what is keeping the economy afloat is the huge black economy. It is the poor who have been bearing the brunt of inflation silently and apart from facing high food prices, their own housing, transportation, jobs, children's schooling and healthcare have all remained stressed due to corruption and has caused widespread discontent.

The fiscal deficit target of 4.8 per cent of the GDP and the revenue deficit target, however, will have to be met and it will mean cutting expenditure. Yet the various subsidy programmes of the government will require big-ticket financing, which may make it difficult to cut expenditure. Revenue collection, on the other hand, is facing a slowdown and has been slower than normal this year. Any further borrowing of funds by the government from the market would create inflationary pressures. Proper management of food supplies will also be imperative.

The government is perhaps keen on projecting a welfare-oriented profile in which the poor are looked after. This would contrast with the corporate-oriented outlook of BJP prime ministerial candidate Narendra Modi in the forthcoming LokSabha elections. The promise of welfare measures can go down well with the public in the May 2014 elections provided the government manages to rein in inflation and reduces corruption. A government that cares is important for the poorer sections than the one in which the rich are given more incentives and sops for promoting growth. The UPA government has assured the people food security and will do well to increase expenditure on healthcare but with so many additional expenditures, its hands are tied. It is in a bind because while meeting the fiscal deficit will require a 'hair cut' or austerity, the expectations from the government would be for more welfare schemes and sops by the public.

More than anything else, the government's image of delivering public goods to the poor efficiently and smoothly would be most important. It is also a corruption-free government that people are looking for and not one with more welfare schemes that are announced but not implemented. Prices, jobs, higher industrial growth and prospects of rapid economic recovery will remain the most important planks on which the next elections will be fought. The RBI's latest move of not raising the repo rate may also help in economic recovery.

(The writer is a Senior Fellow at Observer Research Foundation, Delhi)

Courtesy : The Tribune, December 20, 2013

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David Rusnok

David Rusnok

David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany

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