RBI pause hints at expansive fiscal steps in Budget

The Reserve Bank of India (RBI) appears to have lost its way. From its original mandate of inflation targeting, which envisages calibrated tightening, it moved on to an accommodative stance in February this year, and rightly so, because the decline in economic growth warranted that.

In Governor Shaktikanta Das’ 12-month old tenure, the repo rate was cut for five consecutive times to support the economy.

After the last monetary policy committee meeting in October, when Das-led MPC relaxed the interest rate for the fifth time, he had said he was surprised that the GDP had fallen to 5% in the June quarter.

It was sharply below the estimates given by the MPC. The RBI had put its research and analysis wing at work to assess such a large variance following that. If that was surprising, then the growth numbers in the September quarter at 4.5% was nothing less than a shocker.

And, the nominal GDP, which includes price changes due to inflation, has all but collapsed. Still, the RBI chose not to cut the repo and stunned the street.

This time around, when the rate was paused, the MPC cited inflation as the reason. Inflation has spiked and it has crossed RBI’s medium-term target of 4%.

But the major pressure on the headline inflation number is coming from vegetables, the price movement in which is seasonal and is not going to stay for long.The new vegetable crop is expected to arrive in January-February and the prices will come off highs. The RBI’s attention to vegetable price spike at a time when the economic growth rate has almost halved in the past five quarters is hard to digest.

If the RBI feels it is restrained to cut rates now due to high inflation, its hands are going to be tied even more during the next two to three policies. The price pressure on commodities and base effect suggest inflation will remain in a higher trajectory of 5% and above till March next year.

The claim that it is seeing green shoots of recovery on the macro-economic front is not supported by the contemporary data on lead indicators such as bank credit growth, industrial production numbers and trade data.

In such a scenario, has the RBI pushed its decision on rate cut because it is waiting to see the extent of the government’s fiscal slippage this year and then decide on its next move?

This will be known in the upcoming Union Budget. Obviously, both, fiscal and monetary policies cannot afford to be expansionary at the same time. The central bank could have some inkling that the Centre’s fiscal assumptions for the next year may be higher than the usual.

The economy has plummeted to a multi-year low and the supply-side measures are not producing desired results. There is a clear sense in Governor’s speech that the RBI wants to wait to see what counter-cyclical measures the government announces in the Union Budget.

The government is under huge pressure to push up demand-side measures and lift consumption.

The latest RBI survey has indicated that both consumer confidence and business confidence continue to run low.

Boosting consumer confidence can only happen when money comes directly into the hands of people. Finance Minister Nirmala Sitharaman has, of late, dropped enough hints on her readiness to address demand-side measures and sought suggestions from the industry and trade bodies on rationalising income tax and other levies.

Fiscal deficit

Expectations were high from the government for an income tax relief to middle-class taxpayers, after the finance minister gave an unexpected cut in corporation tax in August. But slowing revenue collections posed an impediment.

The situation is no better now if the government decides to follow the fiscal glide path and sticks to the target of 3.3% this year. But the industry has suggested the government should allow its fiscal deficit to increase by 0.5% to 0.75%, which could give it an additional fiscal space of Rs 1.1 lakh crore to Rs 1.6 lakh crore.

Industry body CII has even gone on suggesting that the government reduce personal income tax rates to enhance disposable income, especially at the bottom of the pyramid.

“This will increase household demand as well as enhance sagging household savings. Further, CBDT can constitute an expert panel of mediators to mediate and try to resolve tax disputes at the assessment stage itself in a time-bound manner. This will boost sentiments and augment revenues,” the CII said in its submission to the finance ministry ahead of the Union Budget.

There are about nine crore individuals, who pay income tax in India. More than two crore file income tax return but do not pay income tax.

But giving more money in the hands of this minuscule population has a multiplier effect on the economy in terms of spending, creating jobs for many in formal and informal sectors.

However, the government which earns over 23% of its tax revenues from personal income tax, does not want to let go this from its hands because among other things it impacts fiscal deficit and hits its credibility.