{"id":509,"date":"2012-06-23T05:19:00","date_gmt":"2012-06-23T05:19:00","guid":{"rendered":"http:\/\/teekhapan.wordpress.com\/?p=509"},"modified":"2012-06-23T05:19:00","modified_gmt":"2012-06-23T05:19:00","slug":"the-difficulty-of-being-duvvuri-subbarao","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2012\/06\/23\/the-difficulty-of-being-duvvuri-subbarao\/","title":{"rendered":"The difficulty of being Duvvuri Subbarao"},"content":{"rendered":"

\"\"<\/a>
\nVivek Kaul
\n<\/strong>
\nDecisions are of two kinds. The right one. And the one your boss wants you to make. The twain does not always meet.
\nDuvvuri 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%.
\nThe Finance Minister, Pranab Mukherjee, declared openly that he was \u201cconfident that they (the RBI) will adjust the monetary policy,\u201d 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.
\nBut 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.
\nThe credibility of a repo rate cut
\n<\/strong>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\u2019t have been able to cut interest rates.
\nBetween 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?
\nHigh fiscal deficit
\n<\/strong>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.
\nThe government finances its fiscal deficit by borrowing. When a government borrows more, as has been the case for the last few years, it \u2018crowds out\u2019 the other big borrowers like banks and corporates. This means that the \u2018pool of money\u2019 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.
\nHigh inflation
\n<\/strong>What must have also influenced Subbarao\u2019s 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.
\nTo conclude
\n<\/strong>In a scenario where the inflation is over 10%, cutting interest rates can fuel further inflation, which isn\u2019t good for anyone. The RBI in a release said that the inflation is \u201cdriven mainly by food and fuel prices.\u201d That\u2019s something Subbarao cannot do anything about and is for the government to sort out.
\n\u201cIn the absence of pass-through from international crude oil prices to domestic prices, the consumption of petroleum products remains strong\u2026preventing the much needed adjustment in aggregate demand,\u201d 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.
\nIn fact in a rare admission Subbarao even said that the last cut in the repo rate in April may have been a mistake. \u201cThe 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,\u201d the RBI release said.
\nWhat 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\u2019t happened. RBI kept its part of the deal. The government did not.
\nThe article originally appeared in the Times of India Crest Edition on June 23,2012.
\n<\/strong>
\n(Vivek Kaul is a writer and can be reached at vivek.kaul@gmail.com)
\n<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

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 … <\/p>\n

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