Rajan puts the ball in govt's court

The RBI wants to seriously watch the Centre's political will on fiscal consolidation steps in the budget.

RBI Governor Raghuram Rajan has taken a cautious decision of wait and watch by maintaining status quo on the policy rates. Rajan, in the same breath, has sternly cautioned the government that the central piece of the ensuing budget should be fiscal prudence and consolidation.

The repo rate – the rate at wh-ich banks borrow from the RBI – continues to be at 6.75 per cent and cash reserve ratio (CRR) – share of deposits which banks must part with the RBI – which does not earn any interest, remains unchanged at 4 per cent. Reduction in these rates would have injected liquidity into the cash starved system, which has been the bankers’ plea, for long.

Categorically, the governor has put the ball in the government’s court. The RBI wants to seriously watch the commitment levels and the political will of the government on the fiscal consolidation measures that would be articulated in the budget. Any upward revision from the fiscal deficit target of 3.5 per cent for fiscal 2016-17 will make the  RBI red faced as it fuels inflation.

Moreover, we have already crossed 90 per cent of the present year’s deficit target of Rs 5.5 lakh crore which is 4 per cent of our GDP. The governor is against boosting growth thro-ugh high expenditure as “grow-th multipliers on the government’s spending will be smaller and hence more spending will hurt the debt dynamics”.

Rajan is concerned on the inflation front too. He has candidly spelt out that we would achieve 6 per cent inflation based on the consumer price index (CPI) in January 2016. But the 5 per cent inflation target for FY 2017 is a challenge as the RBI has not factored the huge impact on the money out go of the wage hike recommendations of the Seventh Pay Commission.

The CPI inflation is inching forward from 5.4 per cent in November to 5.6 per cent in December and expected to touch 6 per cent by February end, culprit being food inflation (pulses, edible oil, sugar). This is coupled with steady rise in the inflation fuelled in the services sector – health care and education which contributes 26 per cent weightage in the CPI.

The impact will have a double whammy effect of 1 per cent reduction in next year’s GDP forecast of 7.4 per cent and fuelling of inflation on account of disposable income that will be available with the people.

The governor is overtly concerned with the deficit planning of both the Central and state governments. This is on account of the haircut that the state governments will be taking for providing guarantees for the Ujwal Discom Assurance Yojana (UDAY) – debt restructuring scheme for state electricity boards wherein 75 per cent of Rs 4 lakh crore bad debts will be converted to bonds backed by the state government guarantees and 50 per cent will materialise before March 2016.

Adverse effects

The pay commission impact, “bleeding” on account of UDAY, populist subsidies that creep into the budget will have adverse effect on inflation and on the fiscal deficit. The windfall benefits from the steep fall in crude oil prices from $100 per barrel to under $30 per barrel, collapse of commodity prices (iron ore, aluminium, steel, copper, platinum) will be washed out from the dole outs of pay commission, unviable subsidies, one rank one pension and UDAY.

Rajan wants banks to address to the painful issue of bad debts and stressed assets which has mounted to the tune of Rs 7 lakh crore. He has assured that there will be no slip up in providing the liquidity support to the banks through its various instruments such as open market operations (OMOs), CRR, dollar purchases etc. He opines that apprehensions of the bankers on lack of liquidity is misplaced.

The RBI hinted on relaxing certain norms for Strategic Debt Reconstruction (SDRs), revaluation of acquired assets in the bank books on present values so that banks can take advantage as at March 2016 for “window dressing” of balance sheets.

For the first time, the governor did not harp on the monetary transmission of the rate cuts by the banks to the borrowers on various loans such as housing, real estate, construction, industries, vehicles and personal loans.

Rajan is confident that this aspect including the lag effect will be taken care of with the introduction of the “marginal cost of funds” from April 2016. This methodology will have variable rates for both deposits as well as loans and hence will avoid the asset liability mismatch.

In sum, the governor has made more noise, even while maintaining the status quo on the policy rates by putting the onus on the government to undertake structural reforms with fiscal prudence and rectitude. The reforms will have to encompass incentivising investments, encourage skill development, overcome supply side constraints.

Long standing bills such as the GST, land acquisition, bankruptcy code, will have to be passed supported by revival of stalled infrastructure projects which contribute 8 per cent of the GDP. With these riders taken care of in the ensuing budget, Rajan has hinted quid pro quo  of a surprise rate cut of 25 bps in March.

(The writer is a Bengaluru-based banker)