How far will PC walk alone down the growth path?

P Chidambaram’s anger with the Reserve Bank of India for not cutting interest rates that are hindering investment comes at a time when the country is facing twin problems of slow growth and high inflation.

However, the UPA’s flip-flop on major policy issues has all but questioned its resolve to walk the growth path alone as stated by the Finance Minister just the other day.

Chidambaram’s disappointment with the central bank came out in the open when he made the statement that if the government has to walk alone to face the challenge of growth, “then we will walk alone”. A day after, Prime Minister Manmohan Singh gave a call for tighter fiscal regime in the wake of the government’s revenues facing strain.

But, a decision soon after to roll back the hike in LPG prices has prompted many to question whether the government can tread alone on a growth path? And whether there is enough fiscal management and any clear-cut fiscal roadmap that can facilitate the government’s move in case the monetary authority does not heed to the call to loosen up?

“There are enough talks, but action is not forthcoming from the fiscal side and that is why the monetary side control is needed,” says Mahesh C Purohit, Director at Foundation for Public Economics and Policy Research. Purohit believes that asking the RBI to cut interest rate in the present regime when the inflation is high and growth is moderating will only worsen the situation.

It is true that the RBI has disappointed Chidambaram by not slashing the interest rate, especially when the Finance Minister had already built up expectations by expressing his opinion on more than one occasion that the RBI was running a tight monetary policy. He had also laid a long-term fiscal roadmap just a day ahead of the October 30 monetary policy review.

But there is very little that the government has shown in reality ever since the central bank cut repo rate by 50 basis points or half-a-per cent in April this year. And, whatever measures have been taken under the fiscal policy ever since the Budget was presented for 2012-13 do not seem to give any confidence to the monetary authority to ease rates any further, says economist at National Institute for Public Finance and Policy, N R Bhanumurthy, .
“The most important deficit in India, at present, is not the fiscal or current account deficit, but is the trust deficit between the fiscal and monetary policy,” he adds.

Chidambaram may have had rising expectations from tax revenues and reform announcements that the government has made in the past couple of months like easing investment in debt, postponing GAAR and raising revenues through disinvestment.
But, analysts are of the view that there is a little scope to either dramatically increase tax collections in a slowing economy or to slash spending in the months ahead, at least on food, fuel and fertiliser subsidies. Then there are the 2014 general elections, which will not allow the government to cut spendings.

There are certain other measures like tax reforms, new banking licences and opening up of insurance, which may or may not become realities, depending on which way the wind blows in the coming months. But there are doubts that the finance minister can do anything dramatic about the massive fiscal deficit in the current environment. Each of the three major worries - investment collapse, raging inflation and a weak balance of payments - can be traced back to the high fiscal deficit.

“In that case, walking ahead alone on the growth path and curbing inflation solely through fiscal measures does not seem feasible,” Purohit says.

Bhanumurthy also expressed surprise on how the government was going to achieve its fiscal consolidation aims all by itself, now that the election movement has picked up. Chidambaram’s disappointment may have stemmed from the fact that investment whether domestic of foreign is taking a hit in the wake of high interest rate regime, but it is also true that the rising inflation has made inflationary expectations sticky and only in a regime of low and stable inflation, can consumers and investors make informed decisions.

But according to the RBI, domestically, the state of the economy is a matter of growing concern. Though inflation has moderated in recent months, it remains sticky and above the tolerance level, even as growth has slowed. “Significantly, these trends are occurring in a situation wherein concerns over the fiscal deficit, the current account deficit and deteriorating asset quality loom large. In this context, the challenge for monetary policy is to maintain its vigil on controlling inflation while being sensitive to risks to growth and other vulnerabilities,” RBI Governor D Subbarao said recently.

So far as the measures taken by the government to stem its fiscal deficit include only a raise in diesel prices, limiting the number of subsidised LPG cylinders, and raising fertiliser prices by a measly Rs 50 a tonne. Analysts say, these are at best the good first steps. But, the government does not have much room and sufficient time to take more similar steps.

“Given the political compulsions of the UPA, it is not much possible to take many more reform measures and stick to a fiscal deficit target o f 5.3 per cent in a slow growth year,” says another economist.

Economy watchers and policy analysts also believe that the Finance Minister, through a supportive fiscal policy should prepare a fertile ground for the monetary policy to fructify. Independent of fiscal policy, the RBI will not be able to achieve any perceivable results and the same holds true for the government, they say.

Inflation is the single-most burning problem after the fiscal deficit. A loose fiscal policy is expected to fan it further, it is widely believed. The last two years have seen the helplessness of the central bank in fighting inflation all alone. The government’s policy-makers have also voiced their disagreement on walking the growth path alone.

According to Prime Minister’s Economic Advisory Council Chairman C Rangarajan, to achieve its potential growth, inflation needs to come down and the government must take “unpopular” decisions in curbing expenditure, adding that monetary and fiscal policies have to play their part in containing inflation and moving on a growth path. It is a widely held view for an overall growth regime that it helps if monetary and fiscal policies move in tandem. Hope the Finance Minister takes this into consideration.