Pranab Mukherjee

Ordinance Raj should not be the way forward for Modi government

narendra_modiVivek Kaul

The union minister for parliamentary affairs M Venkiah Naidu made an interesting comment in July 2014, when he said that the Congress led United Progressive Alliance (UPA) government had promulgated 61 ordinances when it was in power between 2004 and 2014.
This comment has since then been used as an explanation to defend ordinances promulgated by the Narendra Modi government. If they could have done it, why can’t we? Since coming to power the Modi government has promulgated nine ordinances. The latest set of ordinances to be issued included the ordinance to amend the land acquisition act and the ordinance to allow foreign direct investment in insurance companies to be increased to 49% of equity, from the current 26%. Another ordinance regularizing e-rickshaws in Delhi has also been issued.
The reason for the government issuing these ordinances lies in the fact that the opposition parties did not allow the Rajya Sabha to operate in the recent winter session. The Bhartiya Janata Party (BJP) has only 45 out of the 250 MPs that make up the Rajya Sabha. Hence, with the opposition ganging up together, there is no way that the BJP can get any legislation passed through the upper house of Parliament.
This has led to the BJP government promulgating ordinances. The article 123 of the constitution empowers the president to promulgate an ordinance if the Parliament is not in session, provided he is convinced that the situation demands so. What this also means is that ordinances should not be used to get around the opposition that the government might be facing in Parliament. If the government decides to do that, it is in a way putting to test the basic tenets of democracy.
A report in The Indian Express points out that the president Pranab Mukherjee asked the government “to explain the urgency behind the [land acquisition] ordinance.” Three union ministers “put forth the government’s viewpoint and persuaded the President about the need to move swiftly,” the report points out.
The president has the power to return the ordinance to the government if he feels that the ordinance requires reconsideration. Nevertheless, if the government sends back the ordinance to him, he needs to promulgate it.
After promulgating the ordinance allowing the foreign direct investment in insurance companies to be increased to 49% of equity, the finance minister Arun Jaitley said: “The ordinance demonstrates the firm commitment and determination of this government to reform. It also announces to the rest of the world, including investors, that this country can no longer wait even if one of the Houses of Parliament waits indefinitely to take up its agenda.”
Jaitley further added that “already there is too much delay, which is why there is urgency.”
What Jaitley is not saying is that the BJP in its role as the principal opposition party until May 25, 2014, has also been responsible for this delay. In December 2013, Yashwant Sinha, a senior BJP leader and a former finance minister had said that the BJP was willing to support the insurance bill provided the “government shed its obstinate stand of providing 49 per cent FDI in the sector”.
Further, as the principal opposition party in the previous Lok Sabha, BJP regularly stalled proceedings. It is now being paid back in the same coin in the Rajya Sabha. Hence, the party taking a moral high ground on the issue is rather comical. At the same time, the opposition parties not allowing the Rajya Sabha to function is also not democratic. A major function of the Parliament is to legislate and a Parliament that does not legislate is not fulfilling one of its basic purposes.
Another important point that needs to be made here is that justifying the promulgation of ordinances just because the UPA government did the same is a rather weak justification. The UPA government is not really a benchmark for anything when it comes to government or governance. The BJP can and needs to do substantially better than that. They shouldn’t be setting their benchmarks so low.
Further, an ordinance is valid upto six weeks from the date on which the next session of the Parliament starts. After that it lapses. There is no upper limit to the number of times an ordinance can re-promulgated. But that is easier said than done. In this context, the case of DC Wadhwa versus the State of Bihar needs to be discussed here.
The Article 213 of the constitution allows the governor of a state to promulgate an ordinance provided the legislative assembly is not in session. The Bihar government abused this provision to the hilt. Between 1950 and 1966, the Bihar legislature passed 444 Acts. The number of ordinances promulgated during the period stood at 76. The situation then deteriorated and between 1967 and 1981, the number of Acts passed by the legislature were at 180, whereas the number of ordinances passed stood at 2014. As many as 50 ordinances were passed on a single day.
D C Wadhwa, who was the director of the Gokhale Institute of Politics and Economics in Pune, filed a writ petition on this in the Supreme Court. As Swaminathan Aiyar points out in a recent column in The Times of India: “in the Bihar Ordinance Raj case, the Supreme Court said that repeated ordinances were undesirable but not illegal.” PRS Legislative Research points out that: “The Supreme Court argued that if Ordinance making was made a usual practice, creating an ‘Ordinance raj’ the courts could strike down re-promulgated Ordinances.”
The point is that if the Modi government keeps promulgating and re-promulgating ordinances someone could easily challenge it in court. Hence, none of those constituents who are likely to benefit from an ordinance will act on it unless it is passed by both the houses of the Parliament. This means you won’t see any foreign company increasing its stake in the insurance business that it runs in India to 49% any time soon.
The government does not have the numbers to push these laws through the Rajya Sabha. So what can it do? It can call for a joint session of Parliament and hope to pass these laws. But calling a joint session isn’t exactly easy.
A joint session can be called if a bill is rejected either by the Lok Sabha or the Rajya Sabha. Given that the opposition parties haven’t allowed the Rajya Sabha to function, no bill has been rejected. Secondly, a joint session can be called if the there are disagreements regarding amendments between the two houses. That hasn’t happened either. Finally, more than six months need to have passed since the introduction of the bill in either house. If the bill still hasn’t been passed then a joint session can be called.
While the third condition isn’t fulfilled (for the lack of a better word) currently, this is precisely what the government seems to be aiming at. Nevertheless, it needs to be pointed out that only on three previous occasions a joint session of Parliament has been called (the Dowry Prohibition Bill, 1961, the Banking Service Commission (Repeal) Bill, 1978, and the Prevention of Terrorism Bill, 2002).
A joint session is not a workable solution to this deadlock. First and foremost because it delays legislation. A joint session of Parliament cannot be called overnight. Secondly, for a government which has time and again told the country that it has a huge reform agenda, it cannot be held to ransom by the opposition parties, every time it tries to introduce a new legislation. This is likely to be the case over the next few years, until the BJP state assemblies are able to elect enough MPs to the Rajya Sabha. Thirdly, the opposition parties can get together and try and stall a joint session of Parliament as well.
Given these reasons, it is time that prime minister Narendra Modi and his lieutenants drop the aggressive posture and try to engage the opposition parties. The aggression that suited them when they were in opposition will go against them now that they are in government. This is something that they need to think about.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on January 6, 2015

The Singh Talkies



Vivek Kaul
One of my favourite Hollywood comedies is Mel Brooks’ Silent Movie made in 1976. As its name suggests, the film had no dialogue and the only audible word in the movie is spoken by Marcel Marceau, when he utters the word “No!” Rather ironically Marceau was one of the most famous mime artists of the era.
The Congress party led UPA in the last few years has been behaving in the opposite way.In the Congress movie every leader other than Prime Minister Manmohan Singh, the man at the top, had a dialogue. Singh chose to keep quiet rarely telling us what was going on inside his head, as his government moved from one scam to another.
But over the last two weeks he has suddenly found his voice, initiated a wave of reforms, from increasing the price of diesel by Rs 5 per litre to allowing foreign direct investment in the retail sector. “​It will take courage and some risks but it should be our endeavour to ensure that it succeeds. The country deserves no less,” Singh said after the announcements were made.
He even addressed the nation and explained the rationale behind the decisions. The media went to town saying that Manmohan has got his mojo back. But the question is what has got our silent Prime Minister talking?
When Pranab Mukherjee presented the budget earlier this year he had projected a fiscal deficit of Rs 5,13,590 crore or 5.1% of the gross domestic product(GDP). Fiscal deficit is the difference between what the government earns and what it spends.
The projected fiscal deficit has gone all awry primarily because the price of oil has continued to remain high, despite a slowdown in the global economy. Currently, the price of the Indian basket of crude oil is at around $114.4 per barrel.
This wouldn’t have been a problem if the diesel, kerosene and cooking gas, would have been sold at their market price. But the Indian government hasn’t allowed that to happen over the years and has protected the consumers against the price rise. This means that the oil marketing companies (OMCs) Indian Oil, Bharat Petroleum and Hindustan Petroleum have had to sell diesel, kerosene and cooking gas at a loss.
The government needs to compensate these companies from the losses they incur, so that they don’t go bankrupt. These losses were close to touching Rs 1,90,000 crore, when the government decided to increase the price of diesel by Rs 5 per litre. Even after this increase the OMCs will lose over Rs 1,00,000 crore just on the sale of diesel this year. The total loss on diesel, kerosene and cooking gas is now estimated to be at Rs 1,67,000 crore. The OMCs are also losing around Rs 6 per litre on selling petrol, but the government doesn’t compensate them for this.
The government hadn’t budgeted for such huge losses on the oil front in the budget.  The budgeted amount was a miniscule Rs 43,580 crore. Of this nearly Rs 38,500 crore was used to compensate the OMCs for losses made during the course of the lost financial year, leaving a little over Rs 5,000 crore to meet the losses for the current financial year.
The subsidies allocated for food and fertiliser are also likely to be not enough. In fact as per the Controller General of Accounts the fiscal deficit during the first four months of the year has already crossed half of the budgeted fiscal deficit of Rs 5,13,590 crore. This was a really worrying situation. More than that with tensions flaring up again in various countries in the Middle East, it is unlikely that the price of oil will come down in a hurry.
Given these reasons if the government had carried on in its current state there was a danger of the fiscal deficit crossing Rs 7,00,000 crore or 7% of the GDP. This is a situation which India has never had to face since the country first initiated and embraced economic reforms in July 1991. The fiscal deficit for the year 1990-1991 had stood at 8% of the GDP.
Reforms like allowing foreign investment in multi brand retailing will have an impact on economic growth over a very long period of time, if at all they do. Allowing foreign investors to pick up 49% stake in domestic airlines will also not have any immediate impact. But what is more important is the signals that these reforms send out to the market i.e. policy logjam that was holding economic growth back is over and the government is now in the mood for reforms.
As a result the rupee has appreciated against the dollar. One dollar was worth Rs 55.4 on September 14. Since then it has gained 3% to Rs 53.8. This will help in bringing the oil bill down. Oil is sold internationally in dollars. When one barrel costs $115 and one dollar is worth Rs 55.4, India pays Rs 6,371 per barrel. If one dollar is worth Rs 53.8, then India pays a lower Rs 6,187 per barrel. So an appreciating rupee brings down the oil bill, which in turn pushes down the fiscal deficit of the government.
The thirty share BSE Sensex has rallied by 2.9% to 18,542.3 points, from its close on September 13 to September 17. Nevertheless, even after these moves the actual fiscal deficit of the government will be substantially higher than the targeted Rs 5,13,590 crore. To bring that down the government needs to come up with more reforms so that the rupee continues to appreciate against the dollar and brings down the oil subsidy bill. The market rally also needs to continue, so that the government meets its disinvestment target of Rs 30,000 crore for the year. And on top of all this the government also needs to reign in the oil subsidy by gradually increasing prices of petrol, diesel, kerosene and cooking gas. Unless this happens, the government will continue to borrow more and this will keep interest rates high. Interest rates need to come down if businesses and consumers are to start borrowing again. This is necessary to revive economic growth, which has slowed down considerably.
If all this wasn’t enough we also need to hope that a certain Mrs G and Master G need to continue to understand that good economics also means good politics. If they switch off anytime now, Manmohan Singh is likely to go quiet again.
(A slightly different version of the article with a different headline appeared in the Asian Age/Deccan Chronicle on September 26, 2012. http://www.deccanchronicle.com/editorial/dc-comment/good-economics-good-politics-too-426)
(Vivek Kaul is a Mumbai based writer. He can be reached at [email protected])

A policy rate Catch 22


Vivek Kaul

“That’s some catch, that Catch-22,” says Yossarian, the lead character in Joseph Heller’s all time classic Catch 22. Duvvuri Subbarao, the governor of the Reserve Bank of India (RBI) is facing a Catch 22 situation currently and some catch it is.
He needs to decide whether to encourage economic growth or to control inflation. Theoretically Subbarao can encourage economic growth by cutting the interest rates. But that is likely to fuel inflation as people and companies will borrow and spend more, leading to a rise in prices.
He can control inflation by keeping the interest rates high. But that kills economic growth as businesses don’t borrow money to expand and people go slow on taking loans for purchasing cars, motorcycles, homes and consumer durables. This hurts businesses and slows down economic growth.
The RBI seems to be trying to control inflation by keeping the interest rates high rather than try and encourage economic growth by cutting the interest rate. In the first quarter review of monetary policy 2012-2013 which was released on July 31, 2012, the RBI decided to keep the repo rate at 8%. Repo rate is the interest rate at which the RBI lends to banks.
By keeping the repo rate high the RBI hopes to control inflation. “The primary focus of monetary policy remains inflation control,” the RBI said in a statement. But economic theory and practice don’t always go together.
The inflation in India is primarily on account of rising oil prices and food prices. Oil is a commodity that is bought and sold internationally and the RBI cannot control its price. The price of oil has been falling since the beginning of this year but it has started to inch its way back up and as I write this, brent crude oil is quoting at $105per barrel. While the government has shielded the people from a rise in oil price by not raising the price of diesel, LPG and kerosene, petrol prices have been raised.
As far as food is concerned there seems to be a structural shift happening. “The stickiness in inflation…was largely on account of high primary food inflation…due to an unusual spike in vegetable prices and sustained high inflation in protein items,” the RBI said.
Protein items primarily include various kinds of pulses, milk and other dairy items. The various social schemes being run by the current United Progressive Alliance (UPA) government have put more money into the hands of rural India. One thing that seems to have happened because of this is that people are eating better than before.
Economic theory suggests that once income levels rise above $1000 per annum, a major portion of the increased income is spent on more food and better quality food. Also people shift from cereal based diets to protein based diets. In large parts of the world this means an increase in the consumption of meat. But in India it means more consumption of milk and pulses. Again this is something that the RBI has no control over. As long as the UPA keeps running its social schemes this phenomenon of increased food prices is likely to continue.
What does not help in the near term is a deficient monsoon. Rainfall upto July 25,2012 has been 22% below its long period average. This means food prices will continue to rise.
What this clearly tells us is that RBI is not in a position to control inflation as it stands today. So should it be cutting the repo rate and in the process encouraging economic growth?
When RBI cuts the repo rate it is essentially giving a signal to banks that it expects the interest rates to go down in the days to come. But it is upto the banks to decide whether they take that signal seriously. When the RBI cut the repo rate by 50 basis points (one basis point is one hundredth of a percentage point) in April, the banks cut their interest rates by only 25 basis points on an average.
The reason was the increased borrowing by the government to finance its growing fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends. Between 2007 and 2012 the fiscal deficit of the government has gone up by more than 300%. During the same period its income has increased by just 36%.
The fiscal deficit has been growing on account of various subsidies like oil, food and fertizlier being offered by the government. “During April-May 2012, while food subsidies were lower, fertiliser subsidies were more than twice the previous year’s level,” the RBI statement pointed out. What also does not help is the fact that the Rs 43,580 crore oil subsidy budgeted for this year has already run out. The government compensates the oil marketing companies (OMCs) for selling kerosene, diesel and LPG at below cost. With oil prices over $100 again, the oil subsidies are likely to increase in the days to come.
This means increased borrowing by the government to compensate the OMCs for their losses. Increased borrowing by the government will mean that banks will have a lower pool of money to borrow from and hence they will have to continue to offer high interest rates on their deposits and charge high interest rates on their loans.
So what is the way out? “Clearly, if the target of restricting the expenditure on subsidies to under 2 per cent of GDP in 2012-13, as set out in the Union Budget, is to be achieved, immediate action on fuel and fertiliser subsidies will be required,” the RBI said.
But raising prices is easier said than done. Another theory being bandied around is that Duvvuri Subbarao is Chiddu’s baby (P Chidambaram, the Home Minister) and he will start cutting the repo rate as soon as Chidambaram is back at the Finance Ministry.
(The article originally appeared in the Asian Age/Deccan Chronicle on August 1,2012. http://www.asianage.com/columnists/policy-rate-catch-22-677)
The article was written before P Chidambaram was appointed as the Finance Minister
(Vivek Kaul is a Mumbai based writer and can be reached at [email protected])

Pawar is no Mamata di! He is giving the Congress batting practice


Vivek Kaul
“A woman and an elephant never forget an injury,” wrote Hector Hugh Munro better known by his pen name Saki. Wonder whether, Sharad Pawar, the sharp man that he is, has ever read Saki? (On a totally different note, the short stories of Saki are an absolutely delightful read).
The Maratha strongman Sharad Pawar resigned from the Union Cabinet last week. Media reports suggest that he was miffed by the fact that after Pranab Mukherjee decided to retire, and move to the Rashtrapati Bhavan, he was not made the number two in the Union Cabinet .It seems that the defence minister AK Antony has been allocated the seat to the right of the Prime Minister Manmohan Singh, where Mukherjee used to sit, making him number two in the government. And that’s a seat that Pawar had wanted.
The Congress Party has been trying to mollify Pawar and his Nationalist Congress Party (NCP) since he quit a few days back. “In a Parliamentary democracy, all are equal in Cabinet. The Prime Minister is first among equals and there is no number two or number three,” Congress general secretary Digvijaya Singh told the Deccan Chronicle.
That apart it would be rather stupid of Sharad Pawar to assume that the Congress would offer the number two position in the cabinet to him, assuming there was a thing like that. Pawar was one of the first to raise revolt against Sonia Gandhi by bringing her foreign origins to the forefront, after she had taken over as the President of the Congress Party in the late 1990s.
Even before that Sonia and Pawar never shared a great relationship. As Rashid Kidwai writes in Sonia-A Biography “When she (Sonia Gandhi) took over as the Congress chief, there was a certain unease between her and Sharad Pawar. Though Pawar concurred with the party’s decision to request Sonia to save the Congress, he later candidly admitted that he was never comfortable with her. Their conversations never lasted long and even that short duration was punctuated by long pauses.”
On March 14, 1998, the Congress Working Committee unceremoniously shunted out Sitaram Kesri, an elected President, and requested Sonia Gandhi to take over as the President of the Congress.
Kidwai in his book suggests that after Sonia took over as the President of the Congress, Pawar got an informal poll survey done. The results of the survey concluded that if he raised the banner of revolt against Sonia on the issue of her foreign origin, he would be the second Lokmanya Tilak. “The actual findings of the survey were never made public,” writes Kidwai. Things got nasty a little over a year and two months later on May 19, 1999, when Sharad Pawar, P.A.Sangma and Tariq Anwar raised a revolt against Sonia Gandhi on the issue of her foreign origin. Sonia resigned in a huff. But she took her resignation back after the trio was kicked out of the Congress party.
Therefore things went from bad to worse between Pawar and Sonia. “After revolting against her on the ground of her foreign origins, Pawar said that Sonia would never openly speak to him, but a CWC member who had tried hard to bring about a rapprochement between Pawar and Sonia said the same thing about him: ‘We encouraged him to have an open, heart-to-heart discussion with the Congress president, but he would just not open up,’” writes Kidwai.
So all this suggests that Pawar and Sonia share a very uneasy relationship and probably bear each other because of the compulsions of coalition politics. Also Sharad Pawar effectively ensured that Sonia Gandhi never became the Prime Minister of the country. Given that it is highly unlikely that Sonia would appoint Pawar number two in any union cabinet which she effectively controls.
Pawar of course understands this more than anyone else given the shrewd man that he is. So why is then all the drama of quitting in a huff happening? The major reason seems to be the fact that the Maharashtra chief minister Prithiviraj Chauhan is seen to be hurting the interests of the NCP. He has announced a white paper on the irrigation department which has been headed by Pawar’s nephew Ajit Pawar for ten years now.
The other major issue has been with co-operative banks. The Reserve Bank of India had dissolved the board of directors of the Maharashtra State Co-operative Bank which was controlled by Ajit Pawar in May last year. Pawar junior had come down heavily on the manner in which Chavan had implemented the RBI order in haste.
A few months back in March, RBI dissolved the NCP controlled Sangli District Central Cooperative Bank for violation of the Banking Regualtion Act. This move came a week after the NCP leader Dinkar Patel was elected as the Chairman of the Bank.
Chavan has also distanced himself from the refurbished Maharashtra Sadan in New Delhi. Allegations are now being made that relatives and family members of public works development (PWD) minister Chhagan Bhujbal, a senior NCP leader, benefitted considerably from contracts that were awarded out at inflated costs.
The NCP is also unhappy with the fact Chavan is not giving Pawar enough respect. “”In the past, CMs would make it a point to call on him and give him the respect due to a tall leader,” Times of India reported sources as saying.
The other theory going around is that Pawar is worried about the increasing influence of his nephew Ajit among the party legislators. Hence this move of resigning from the union cabinet is also being seen as a pressure tactic to get a ministerial birth for his daughter Supriya Sule, who is a member of the Lok Sabha from the Baramati constituency. As the Times of India on July 22 “Congress sources feel Pawar is shrewdly leveraging his unhappiness with the CM to pressure the Centre on demands ranging from a say in governorships, appointments to various boards, a ministerial perch for daughter Supriya while invoking the coalition mantra. He is also seen to be pitching for a say in Rajya Sabha nominations.”
The game is all about drawing some concessions out of the Congress party. At the end of the day we must remember that Pawar is no Mamata Banerjee. The influence of the NCP is limited to parts of western Maharashtra (primarily in districts around Pune). Pawar and NCP cannot win an election in Maharashtra on their own, unlike Mamata can and did in West Bengal. They need the Congress party as an alliance partner as much as the Congress needs them. The elections in Maharasthra are due in 2014. NCP is a party of business barons who have huge stakes in co-operative banks, sugar co-operatives and education institutes. Given this, it is important for them to remain in government. And they won’t remain in government unless they have a seat sharing agreement with the Congress party.
So what Pawar is doing right now is throwing some tough deliveries at the Congress party to give them some batting practice and hoping that he is able to draw out some goodies from them in the process. In the meanwhile we will some serious rhetoric from the NCP continuing. The one that caught my eye was of Jitendra Ahwad, an NCP leader, recently telling CNN-IBN that Sharad Pawar was the best man to be the Prime Minister.
(The article originally appeared on www.firstpost.com on July 23,2012. http://www.firstpost.com/politics/pawar-is-no-mamata-di-he-is-just-giving-cong-batting-practice-386923.html)
(Vivek Kaul is a writer and can be reached at [email protected])

The difficulty of being Duvvuri Subbarao


Vivek Kaul

Decisions are of two kinds. The right one. And the one your boss wants you to make. The twain does not always meet.
Duvvuri Subbarao, the governor of the Reserve Bank of India(RBI), earlier this week, showed us what a right decision is. He decided to hold the repo rate at 8%. Repo rate is the interest rate at which RBI lends to banks. There was great pressure on the RBI governor to cut the repo rate, after the gross domestic product (GDP) growth for the period between January and March 2012 came in at a very low 5.3%.
The Finance Minister, Pranab Mukherjee, declared openly that he was “confident that they (the RBI) will adjust the monetary policy,” which basically meant that he was ordering the RBI to cut the repo rate. The idea was that once the RBI cut the repo rate, banks would also cut interest rates leading to consumers borrowing more to buy homes, cars and durables. Businesses would borrow more to expand and in turn push up economic growth.
But economic theory and practice are not always in line. Subbarao, probably understands this much better than others, though until very recently he had largely stuck to doing what his boss the Finance Minister, wanted him to do. For the first time he has shown signs of breaking free.
The credibility of a repo rate cut
By cutting the repo rate the Reserve Bank essentially tries to send out a signal to banks that it expects interest rates to come down in the days to come. If banks think the signal is credible enough then they cut the interest rates they pay on their deposits as well as the interest rates they charge on their long term loans like home loans, car loans and loans to businesses. But the trouble is that even if the RBI cut the repo rate, the credibility of the signal would be under doubt, and banks wouldn’t have been able to cut interest rates.
Between the six month period of December 2, 2011, and June 1, 2012, banks have given loans amounting to Rs 4,46,563 crore and have borrowed Rs 4,27,709 crore. Hence for every Rs 100 that the banks have borrowed they have lent out Rs 104, which means they have not been able to raise enough deposits during to match their loans. So their ability to cut interest rates is limited. The question is why is the money situation so tight?
High fiscal deficit
The government of India has been running a very high fiscal deficit. For the financial year 2007-2008, the fiscal deficit stood at Rs 1,26,912 crore. It shot up to Rs 5,21,980 crore for 2011-2012. In a time frame of five years the fiscal deficit is up nearly 312%. The income earned by the government has gone up by only 36% to Rs 7,96,740 crore, during the same period. The huge increase in fiscal deficit has primarily happened because of the subsidy on food, fertilizer and petroleum. For the current financial year, the fiscal deficit is projected to be at Rs 5,13,590 crore, which is likely to be missed as has been the case in the last few years. The oil subsidy targets have regularly been overshot. This year the government might even overshoot the food subsidy target of Rs 75,000 crore.
The government finances its fiscal deficit by borrowing. When a government borrows more, as has been the case for the last few years, it ‘crowds out’ the other big borrowers like banks and corporates. This means that the ‘pool of money’ from which banks and companies have to borrow comes down. Hence, they have to offer a higher rate of interest. This is the situation which prevails now. So banks will continue in the high interest rate mode.
High inflation
What must have also influenced Subbarao’s decision is the high inflationary which prevails. The consumer price inflation for the month of May stood at 10.36%. This is likely to go up even further in the days to come given that the government recently increased the minimum support price(MSP) on khareef crops from anywhere between 15-53%. These are crops which are typically sown around this time of the year for harvesting after the rains. The MSP for paddy (rice) has been increased from Rs 1,080 per quintal to Rs 1,250 per quintal. Other major products like bajra, ragi, jowar, soybean etc, have seen similar increases. This will further fuel food inflation. Also, after dramatically increasing prices for khareef crops, the government will have to follow up the same for rabi crops like wheat. Rabi crops are planted in the autumn season and harvested in winter. Economists expect higher MSP on agriculture products to push up the food subsidy bill by Rs 40,000 crore from its current level of Rs 75,000 crore. This means a higher fiscal deficit and in turn higher interest rates.
To conclude
In a scenario where the inflation is over 10%, cutting interest rates can fuel further inflation, which isn’t good for anyone. The RBI in a release said that the inflation is “driven mainly by food and fuel prices.” That’s something Subbarao cannot do anything about and is for the government to sort out.
“In the absence of pass-through from international crude oil prices to domestic prices, the consumption of petroleum products remains strong…preventing the much needed adjustment in aggregate demand,” the RBI release said. The Subbarao led RBI seems to be clearing telling the government here to cut down on oil subsidies by increasing fuel prices as and when necessary.
In fact in a rare admission Subbarao even said that the last cut in the repo rate in April may have been a mistake. “The Reserve Bank had frontloaded the policy rate reduction in April with a cut of 50 basis points. This decision was based on the premise that the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives,” the RBI release said.
What this means in simple English is that the RBI may have been led to believe by the finance ministry that if they went ahead and cut the repo rate in April, the government would follow up by taking emasures to cut the fiscal deficit. But that hasn’t happened. RBI kept its part of the deal. The government did not.
The article originally appeared in the Times of India Crest Edition on June 23,2012.

(Vivek Kaul is a writer and can be reached at [email protected])