Second Quarter Review of Monetary Policy 2013-14 and Decoding Rajanomics

Reserve Bank of India (RBI) had announced its Second Quarter Review of Monetary Policy 2013-14 recently (i.e. on 29^th Oct 2013).  In its Policy RBI had said the following major stance

1. Reduction of marginal standing facility (MSF) rate by 25 basis points from 9.0 per cent to 8.75 per cent with immediate effect;
2. Increase  in policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.5 per cent to 7.75 per cent with immediate effect; and
3. The liquidity provided through term repos of 7-day and 14-day tenor has been increased from 0.25 per cent of net demand and time liabilities (NDTL) of the banking system to 0.5 per cent with immediate effect.

In its policy RBI had said that it is more concerned on Inflation along with the growth rate – “Curbing mounting inflationary pressures and managing inflation expectations will help strengthen the environment for growth by fostering macroeconomic and financial stability. The Reserve Bank will closely monitor inflation risk while being mindful of the evolving growth dynamics.”  (for full policy click here)

Two days after policy announcement RBI Governor Mr. Raghuram Rajan has said that tough measures like raising rates are needed to tackle inflation in India (In an exclusive interview to NDTV’s Mr. Prannoy Roy). Dr Rajan's said to India Inc is: Bear with us. If we don't fix inflation now, the problem will get worse. (For Highlights and full Interview video click here)

My Perspective

I am little surprised on reading the Second Quarter Review of Monetary Policy 2013-14 (to read second quarter review click here). The second quarter review says that "Strengthening export growth and signs of revival in some services, along with the expected pick-up in agriculture, could support an increase in growth in the second half of 2013-14 relative to the first half, raising real GDP growth from 4.4 per cent in Q1 to a central estimate of 5.0 per cent for the year as a whole (Chart 1). The revival of large stalled projects and the pipeline cleared by the Cabinet Committee on Investment may buoy investment and overall activity towards the close of the year." Not for the reason that RBI had estimated GDP growth of 5.0 per cent for whole year but for the statement - revival of large stalled projects!!! These large projects are stalled for past 2 to 3 years; they got to be revived because election is on card now. 

I saw the full interview of RBI governor to NDTV (click here for Transcript), Where Dr. Rajan said that ".........Oh, these guys don't have manufacturing", that's really why they are in the dumps. No. No. That's not why we are in dumps. We are slowing down because we expanded too fast and we have these..." "Dr Prannoy Roy: Old Systems."  and "Dr Raghuram Rajan said Yes"

When Dr Prannoy Roy asked that: So what you are saying is with these old systems, if these remain in place, our growth rate is going to be capped at 4 to 5 percent. If we change the system we can go back to our 9-10% on a long-term basis.

Dr Raghuram Rajan: See 7-8 is what is feasible. These are all numbers, guess work.

This surprised me because our manufacturing sector is widely affected and it is a fact that we have weak manufacturing sector. Even the IIP data replicates only 0.6 percent growth over last year. If we are not worried about our manufacturing sector now, then when!!! In his Monetary Policy statement as well as in his interview, RBI Governor, talked about changing financial systems. This is another alarming thing (at least from my perspective) because this statement means two things either we have a weak financial system (this includes inefficient structure, where financial system fails to absorb shocks) or outdated financial system (which also means the flow of money in the economy is not that smooth)!!! 

Financial system is a engine for any economy; if that fails then economy will be in trouble. It is still too early to say where Indian Economy is heading to!!! We need to wait and watch!    

KAUTILYA's Principles of Taxation and ADAM SMITH's Canon of Taxation

Kautilya alias Vishnu Gupta (who is famously known as Chanakya) was an Indian politician, strategist and writer. He is well known for his text "ARTHASHASTRA". He lived during 350 BC-275 BC. 

Adam Smith, Father of Economics, is well known for his famous book "The Wealth of Nations". He  lived during 1723 AD–1790 AD. 

What's common between the Both or Why I am mentioning about both of them here now? Kindly read both Kautilya's Principle of Taxation and Adam Smith's Cannons of Taxation that are as follows:

KAUTILYA'S Principles of Taxation:

1. Taxation should be Such that it may not be felt by the Poor.

2. In raising taxes higher, it should be done little by little when the realms prosperity is increasing. It should be Mild.

3. Taxes should be levied on Proper Places at proper time in a proper form.

4. It should be reasonable and equitable.

ADAM SMITHS Cannons of Taxation:

1.Cannon of Equality :- Ability to pay principle.

2.Cannon of Certainity:- The amount of tax should be Paid.

3.Cannon of Convenience:- Less burdensome to tax payer.

4.Cannon of Economy:- tax should be collected to minimum Possible Level.

This is just a small comparison between Kautilya's Principles of taxation and Adam Smiths cannon of taxation.  I am leaving this post open  to you.

Some Freaknomics? - For a Change!!

As per our Constitution, Article 47 states that "Government shall endeavour to bring about the prohibition of the consumption (of alcohol) except for medicinal purposes of intoxicating drinks." In reality this completely fails.

Many of us know that, Alcohol consumption is steadily increasing in developing countries like India and decreasing in developed countries from 1980’s.  It was estimated that that are 62.5 Million alcohol users in India. A study shows that per capita consumption of alcohol increased by 105.7% between 1970 and 1996 (over the 15-year period) (Source: Alcohol related harm in India – a fact sheet by INDIAN ALCOHOL POLICY ALLIANCE)

India is generally regarded as a traditional ‘dry’ or ‘abstaining’ culture (Bennet et al, 1993). Yet, it has one of the largest alcohol beverage industries in the world. The UB Group, for example is the third largest spirits producer in the world after Diageo and Pernod Ricard (ICAP, 2006c). India is the dominant producer of alcohol in the South-East Asia region (65 percent) and contributes to about 7% of the total alcohol beverage imports into the region. More than two thirds of the total beverage alcohol consumption within the region is in India.

There has been a steady increase in the production of alcohol in the country, with the production doubling from 887.2 million litres in 1992-93 to 1,654 million litres in 1999-2000 and was expected to almost treble to 2300 million litres (estimated) by 2006-07 (The Planning Commission  of India, 2003).

Though consumption is still low, patterns of alcohol consumption vary widely through the country. Punjab, Andhra Pradesh, Goa and the north-eastern states have a much higher proportion of male alcohol consumers than the rest of the country. Women tend to drink more in the states of Arunachal Pradesh, Assam and Sikkim in north-east; Madhya Pradesh, Chhattisgarh, Orissa and Andhra Pradesh in central and east India; and Goa in the west, compared to other states. 
(Source:F-Current Patterns and Trends – ALCOHOL ATLAS OF INDIA –WHO)

This is the trend shown in the recent study on Alcohol in India. Now, when it comes to revenue part there is large part of revenue come from Liquor. In 2006-07 the combined earnings of States from alcohol were estimated about Rs. 30,000 crore which was over 11.5% of tax revenues. In fact, liquour was the second largest contributor to the State’s aggregate revenue kitty after sales tax  which was Rs 1,20,709.15 crore.

The revenue generation from alcohol is a national phenomenon. Karnataka is leader with the excise collection of Rs. 4060 Crore while Uttar Pradesh is in second followed by Andhra Pradesh in third with Rs. 3650 Crore and Rs. 3250 Crore respectively. 

(Source: Can govt ignore alcohol's revenue earnings? - IBN)

My Reflection:

India is the one of the largest producer of Alcohol. This news may not be surprising to many of us; but, the thing is our constitution says one thing and the reality is totally different. The worried part is consumption of alcohol by youngsters has increased from 2 percent in 1990 to 14 percent in 2006 (below the age of 21) and among adults (between age group of 21-30) it is increased from 29 percent to 35 percent in the same timeline. One side the per capita consumption of alcohol is increasing on the other side Government revenue from alcohol is also increasing; whether the revenue from this is utilised for some development purpose or again it goes only to produce more alcohol that's a big question mark ?

Note: TASMAC (Liquour Company owned by Government of Tamil Nadu) revene for 2011-12 was Rs. 18, 081.16 Crore with increase of 20.82% and This year Kerala saw Rs. 70 Crore worth sale of alcohol during two onam days. The entire week revenue was approximately Rs .720 Crore. As per the recent study  Punjab tops the sale of alcohol followed by kerala.

CRR DEBATE – Whether CRR will survive?

During the past few weeks, in the newspapers and televisions, many would have read, saw, and heard that whether CRR is required or it should be abolished? In fact, the close follower of this news would have noticed that the debate was initiated by SBI chairman, Mr. Pratip Chaudhuri and in response to his comment (on abolishing the CRR) RBI Deputy Governor Mr. K. C. Chakrabarty said that CRR is the only and important tool with RBI and it cannot be abolished.

Before going further let us see what exactly CRR is and its purpose?  Cash Reserve Ratio (CRR) is ratio of reserves at which commercial banks must hold or deposit with the central Bank. In other words it is a central bank regulation that sets the minimum reserves that each commercial bank must hold physically in bank vaults or as deposits made with the central bank. This reserve can be maintained either in cash, gold or unencumbered government securities.

The reserve requirement, on one hand, helps the bankers to have enough cash to meet any crisis and on the other hand, they serve as tools for Central Bank to control the liquidity in the system in order to manage the Inflation. When CRR is altered then the interest rates will be changing as per availability of funds with the commercial banks.

Now coming back to the debate that SBI Chairman said Abolish Cash Reserve Ratio, he said that "CRR does not help anybody. It is locked up in the vault and not ploughed back into the economy. It is unfairly applied on banks. If CRR is a liquidity mop-up tool, why not apply it to insurance companies, NBFCs and debt mutual funds, who as well mobilize deposits from the public?" he asked.

After three days of SBI chairman commented the RBI Deputy governor K C Chakrabarty commented that “the banks must work within the frame work of the regulatory norms”. He also said that “If SBI is not protected, the risk may catch other banks leading to a systemic failure and SBI is too big to fail.” He further went on to say that “If the SBI Chairman is not able to do business as per our regulatory environment, he has to find some other place”

This row has become a big debate now. Recently, Reserve Bank of India Governor D. Subbarao made a prank up his sleeve at a banking summit in Mumbai. In serious tone he announced that central bank has set up a ‘committee’ to review the need to retain the much-debated cash reserve ratio (CRR)” But when the Governor revealed the names of the committee members and its conditions, people realised he was only joking.  He said that “The members of the committee, Subbarao said, would be Pratip Chaudhuri, Chairman, State Bank of India, and K.C. Chakrabarty, Deputy Governor, RBI. Both, with opposite views on CRR (the percentage of deposits that banks need to keep with RBI), have sparred over the issue.” He also went on to say further that “the two conditions for such a committee would be: First, the two members would be locked up in a room till they come to an amicable solution. And, second, the findings of the committee should not be made public until his own term as Governor comes to an end.”

So let us see the main reason why SBI chairman said CRR is not required. The main reason for it is that CRR has come down from its peak level of 15% in 1994 to 4.75% at present. Few years ago RBI had ceased to pay interest rate on CRR, which affects the commercial banks. This is one of the main reasons why SBI chairman wanted CRR to be abolished. SBI chairman had got some support for his view from Former RBI governor and present chairman of the Prime Minister's Economic Advisory Council (EAC) C Rangarajan; he said on that there is a need to bring down the cash reserve ratio as the instrument is no longer used in credit control and liquidity management. In his own words "We need to move towards a situation in which the level of CRR comes down and it is used as an instrument of credit control only in extraordinary circumstances," he also stated that "As OMO (open market operations) becomes increasingly a major instrument of credit control, the role of CRR as an instrument of credit control will come down,".
 
Here are 2 more articles on this debate 1.     CRR harsh on public sector banks
2.  CRR has outlived utility

My perspective with a Thank Note:

When one reads the debate then one may come to a quick conclusion that SBI governor is right and CRR should be abolished. If CRR is abolished then what are the other tools through which RBI can control credit and inflation? (Even though this is not the only tool to the do this, but one of the major tool for RBI). No doubt as EAC chairmen said that OMO becomes increasingly a major instrument of credit control, but at the same time we cannot ignore or doubt the credibility of CRR. The Problem with commercial banks is few years back RBI had stopped paying interest rates on the cash reserves; this affects the business of the commercial banks, because without any incentive when the cash is kept then it is no use for anybody. RBI need to find a amicable solution to stop this debate, either by paying some interest rates or through some other incentives. 

I wanted to end this big post with a THANK note to all the Visitors who had viewed, read, visited and commented on this blog. Today, with the help and support from all of you, this blog had crossed 4000 visitors (which you can see in the left side of the screen). I Thank  all of you again for giving your support and encouraging me to keep posting in this Blog. THANKS ALL
  

 

Fiscal Deficit in INDIA – Is it worrisome?

The recent discussions on the Economic growth of developed and emerging nations are all talking about fiscal deficit. In the past few months there was debate going on, on India’s Fiscal Deficit. Whether it is acceptable or it’s too high, what may be the consequences, etc. Before going further on India’s fiscal deficit let me come back to the basic definition of Fiscal Deficit.

BASIC  LESSONS:

What is Fiscal Deficit?  

        

The fiscal deficit is the difference between the government's total expenditure and its total receipts (excluding borrowing). The components of the fiscal deficit are (a) the revenue deficit, which is the difference between the government’s current (or revenue) expenditure and total current receipts (that is, excluding borrowing) and (b) capital expenditure. The fiscal deficit can be financed by borrowing from the Reserve Bank of India (which is also called deficit financing or money creation) and market borrowing (from the money market that is mainly from banks).

India's Fiscal Deficit during Eleventh Five Year Plan (2007-12)

2007-08	2008-09	2009-10	2010-11	2011-12
2.5	6.0	6.5	5.2	5.8

Source:  Data Tables, Planning Commission; Note:  2010-11 Quick Estimates and 2011-12 Advanced Estimates

Is Fiscal Deficit is really a necessary evil or is it really bad? Well to answer this question we need to do some introspection about the economic conditions first. It is not easy to say that fiscal deficit is bad or necessary evil for any economy. It depends entirely on the economic conditions of the country. If Government is borrowing money for some productive purpose through which economic productivity will be increased then fiscal deficit is not bad at all. If an economy like India is investing money in infrastructure and social sector (to have better standard of living) which is properly utilized then Fiscal deficit is not bad or evil.

       

Then one needs to understand why many economist say Fiscal Deficit is bad? Fiscal deficit becomes worrisome or bad when it becomes large and persistent for few years. If it becomes large and persistent then it means that Government is spending money (through borrowing) on unproductive purpose that does not stimulate the economy to move further. When there is a large Fiscal Deficit then there is a significant chance for high level of inflation. When there is high inflation and large Fiscal Deficit then it will lead to fall in value of (or) weaker national currency which is turn reduce the credit-worthiness of the country!

My Perspective:

Now coming back to the news that everybody is concerned about Fiscal Deficit and many ratings firms downgraded India by citing the Fiscal Deficit and Inflation. Is India is really doing bad? Well, if one does a good research on this subject then he will find out the real truth! Yes, India's Fiscal Deficit to GDP is high; no doubt in it, but, at the same time India has the capacity to absorb Government Spending (through borrowing). But, what really concerns is that the  Government Spending (through borrowing) is not happening largely in productive manner. This is one of the reasons for the prevailing high level Inflation rate. This does not mean that India is doing badly; this means that India should be more vigilant on the area of spending (through borrowing). India's Fiscal Deficit will be acceptable only when its Government Spending (through borrowing) happens in more productive manner.  

I wanted to clarify, one thing, that in recent past many Economists, Researchers, and Analyst quoted that this much percentage of Fiscal Deficit is acceptable for any economy or some particular economy. But, I personally believe as what I said earlier that it  depends on economic conditions and capacity of the country. There is no benchmark or ideal percentage for the Fiscal Deficit (as a percent of GDP)

FINALLY A NEW SERIES FOR CPI

          The Central Statistics Office (CSO) of the Ministry of Statistics & Programme Implementation (MoSPI) announced that the new series of Consumer Price Index(CPI)  numbers for Rural, Urban and Combined (Rural +Urban) on base 2010 (January to December)=100 taking all segments of rural and urban population. The CSO, MoSPI releases Consumer Price Indices (CPI) on base 2010=100 for all-India and States/UTs separately for rural, urban and combined every month with effect from January, 2011. 

          These indices is classified into five major groups namely Food, beverages and tobacco; Fuel and light; Clothing, bedding and footwear, and Miscellaneous. It is believed that (at least now we can say!) past CPI numbers do not encompass all the segments of the population in the country and as such they do not reflect true picture of the price behavior in the country; hence the new series of CPI.

          In the new series (for urban areas) the regular price collections of 310 towns have been selected across the country which includes State/UT capitals. A total of 1114 price schedules containing an average of 250 Items are canvassed every month. For Rural areas, total of 1181 villages have been selected across the country. One schedule containing an average of 225 items from each selected village is canvassed for every month. CSO will compile the national CPI by Combining / merging CPI of both Rural and Urban with appropriate weights, as derived from NSS 61^st round of Consumer Expenditure Survey (2004-05) data.

   

New series of CPI-- All India weights
Sub group/group	Rural	Urban	Combined    (Rural+Urban)
Cereals and products	19.08	8.73	14.59
Pulses and products	3.25	1.87	2.65
Milk and milk products	8.59	6.61	7.73
Oils and fats	4.67	2.89	3.90
Egg, fish and meat	3.38	2.26	2.89
Vegetables	6.57	3.96	5.44
Fruits	1.90	1.88	1.89
Sugar etc	2.41	1.26	1.91
Condiments and spices	2.13	1.16	1.71
Non- alcoholic beverages	2.04	2.02	2.03
Prepared meals etc	2.57	3.17	2.83
Pan, tobacco  and Intoxicants	2.73	1.35	2.13
Food, beverages and tobacco	59.31	37.15	49.71
Fuel and light	10.42	8.40	9.49
Clothing and bedding	4.60	3.34	4.05
Footwear	0.77	0.57	0.68
Clothing, bedding and footwear	5.36	3.91	4.73
Housing		22.53	9.77
Education	2.71	4.18	3.35
Medical care	6.72	4.34	5.69
Recreation and amusement	1.00	1.99	1.43
Transport and communication	5.83	9.84	7.57
Personal care and  effects	3.05	2.74	2.92
Household requisites	4.48	3.92	4.30
Others	1.12	0.99	1.06
Miscellaneous	24.91	28.00	26.31
All Groups	100.00	100.00	100.00

My Reflection

             Finally, the new series of CPI has come into existence. Many people may not be aware that the CSO was supposed to release the CPI new series for States/UTs and all – India was expected to from 18^th February, 2011. But, the new series is released this year 18^th April, 2012. I can only say that “It's never late than never”.