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Wednesday, Sep 04, 2002

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RBI Annual Report for 2002-02 — Stressing the need for social vision

P. R. Brahmananda

The RBI Annual Report for 2001-02 reveals that, for the first time after 1977-78, there has been a modest current account surplus in the balance of payments. But the inflation rate continues to move upwards. It would be good to bring down the threshold in the interest of the large vulnerable sections of the population. Neither the Finance Minister nor the RBI can adopt an elitist stance in a poor country, says P. R. Brahmananda.

THE statutory Annual Report of the Reserve Bank of India for 2001-2002 has just been released. The RBI does not exercise any effective control over the real sector developments. It is charged with the responsibility of maintaining monetary equilibrium along with exchange rate management as would be in the best interests of the country. Over the years it has been saddled with many responsibilities not directly related to the above objectives. It is the banker to the Government and a lender of last resort to commercial banks.

The RBI is also expected to exercise a measure of supervision over financial institutions as also in the non-banking sector. It is also concerned with overseeing the priorities in advances of the banking sector and it is here that loans to agriculture, foodgrains procurement and the export sector get its top attention.

Over the years, it has refined its tools to perform the multiple functions. In theory, control and regulation of supply of monetary magnitudes, the control and regulation of interest rates and management of the exchange rate belong to the realm of the RBI. But the big foot of the fiscal authorities does step on the central bank's small feet and, consequently, the RBI's policies are more determined by the fiscal authorities than by its own perspectives of macro requirements.

The most important achievement in 2001-02 was the modest current account surplus in the balance of payments. This is the first time after 1977-78 that a surplus has been reflected in the current account. In fact, over 51 years — from 1950-51 to 2001-02 — the current account surplus has been achieved only in nine, most of them during the 1950s and in 1976-77 and 1977-78.

The measure of the current account surplus in 2001-02 in placed at 0.3 per cent of GDP and we should be grateful primarily to the IT sector and the inflows of deposits from abroad for this remarkable event. This is all the more commendable because in that year we had a 2.2 per cent decline in the growth of exports and a 1.1 per cent increase in the growth of imports.

It is further noteworthy that foreign exchange reserves saw a $12-billion increase during the year, the highest increase in the post independent period. Dr Jalan and the other authorities in the RBI should be congratulated for this extraordinary measure of success in the international indicators.

Now, about the exchange rate. With regard to the US dollar the exchange rate has fallen about 2.07 per cent. In 1980-81 and 1989-90, the average exchange rate was Rs 12.43 per dollar. In 1992-93 and 2001-02, the average exchange rate was Rs 40.03 per dollar. The exchange rate during the reforms period ruled at about 30 per cent of that during the pre-reforms decade.

Note that the substantial reductions in import duties in the post-1993 period were more than compensated by the average decline in the exchange rate. In effect, the exchange rate policy of the RBI prevented what could have been a virtual collapse of the organised industrial sector. The corporate giants must be thankful to the RBI authorities for deep-cushioning the effects of the reduction in import duties.

But the tragedy is that despite the above cushion and the steep reduction in interest rates, the private corporate business sectors' savings as a ratio of household financial savings through purchases of shares and debentures has been just 1.3 per cent in 2000-01 compared to about 8 per cent in the mid-1990s.

In fact, there has been a fast-declining drift in this sectors' savings ratio to household financial savings in the form of purchases of shares and debentures. The Report notes that the Unit Trust of India, which contributed to 4.3 per cent of financial savings in 1993-94, has for the first time shown a negative savings ratio to financial savings (-0.5 per cent) in the form of shares and debentures. However, mutual funds other than the UTI have performed better than the latter in regard to savings contribution to shares and debentures.

Overall, shares and debentures contributed financial savings of just 0.3 per cent of GDP. Actually, in the mid-1990s, their contribution was about 1.7 per cent. The contribution to savings through shares and debentures has been falling consistently, almost in an inverse relation to the attention paid by the finance authorities to these sectors.

The bulk of the financial savings of 12.7 per cent in 2001-02 was contributed by the increase in the form of currency and deposits, their share being nearly 50 per cent of total financial savings. The 16.8 per cent growth in M3 in 2000-01 is primarily responsible for the above contribution. It seems that about 40 per cent of the increase in M3 gets reflected in financial savings.

Insurance funds contribute 12.8 per cent to financial savings, and their share is steadily rising. In fact, it is time the Finance Minister paid attention to the insurance sector rather than to the UTI. The small savings and the insurance sectors together contribute about 25 per cent of financial savings.

Provident and pension funds account for 21 per cent of financial savings. In fact, 95 per cent of financial savings in India currently accrue from increases in M3 holdings, increases in small savings and insurance funds, and increases in provident and financial funds.

Savings through Government bonds and through shares and debentures form just 8 per cent of financial savings. Yet this last sector gains the lion's share of attention in media discussions and in the authorities' perspectives.

The new Finance Minister should aim at shifting the focus on savings to the ignored channels mentioned above. With suitable interest and fiscal incentives, he can help the economy achieve 15-16 per cent of financial savings ratio to GDP. In 1994-95, the financial sector contributed savings to the extent of 14.4 per cent of GDP.

The Report points out that the public sector's contributions to gross savings was negative, at - 1.7 per cent, in 2000-01. The private corporate sector's contribution was 4.2 per cent whereas the household savers have contributed about 21 per cent. Attention has, again, to be shifted to the household sector as the chief potential contributor to savings.

The Report also highlights that gross capital formation in 2000-01 has been just 22.9 per cent of GDP, whereas it was 23.3 per cent in 1999-2000. The big question the Report does not address is why capital formation is not responding to the more than 2 percentage point reduction in interest rates.

Actually, currently the short-term rates in the money market are about 6 per cent. The deposit rates are just 2-2.5 percentage points above this, and the prime lending rates are hovering around 10 per cent.

The yields on long-term bonds have fallen to about 7.5-9 per cent. The inflation rate in 2000-01 was on an average about 3.6 per cent. Real GDP growth rate has been placed at 5.4 per cent. Should not the short-term rates be about 8 per cent in the minimum? The long-term rates should at least be 2-3 percentage points above this.

The policy of reduction in the interest rate has not helped the growth of savings and investment. Interest charges as a private cost do not reflect the fact that for society most of interest income is ploughed back.

In fact, in a society like ours, high interest rates are the most prominent source of incremental savings. There is a conflict between private cost and social cost here, the latter being lower than the former. With the reduction in interest rates, the growth rate of deposits will also be lower, especially of long-term deposits.

The economy's growth over a longer term depends upon investments that add to the capacity to grow. It is here that investment in infrastructure matters.

Again, long-term investments require long-term deposits and loans. The private corporate sector is a satellite sector in the Indian economy. It cannot undertake long-term investments. If the latter do not pick up, the future for the private corporate sector is also bleak.

To promote long-term investment requires long-term social vision. If only the authorities are willing to pay 2-3 per cent more on long-term deposits and use the collections for long-term investment, including in infrastructure, society as a whole will benefit. But the corporate sector's cry for lower and lower interest rates has been so strong that we have forgotten the importance of long-term savings and long-term investment.

The RBI Report notes that the gap between the long-term yields and short-term rates has narrowed sharply. This implies that we have no special consideration for long-term waiting. Without long-term investments, the capacity to grow at a higher rate will be weakened and we will revert to the orbit of growth rates between 5.5 per cent and 4 per cent.

The Report notes that the revenue deficit is as high as 4 per cent of GDP. Unless the Finance Minister takes very bold measures to reduce this to zero per cent, the economy will be continuing to drift at lower and lower growth rate prospects.

The Report notes that policy attention has shifted from money to liquidity. It gives information on the new concepts of money and liquidity, which have been introduced by the Bank in line with international practices.

Liquidity measures indicate that, even if nothing else happens, monetary demand will keep growing to a certain extent. But the important issue is whether production is increasing and investment is also growing. If these do not happen, excess liquidity will become money and, correspondingly, prices will start rising.

The latest information is that the inflation rate is moving ever upwards. The threshold concept of a 4-5 per cent inflation that will not hurt growth is not a given in an economy where the proportion of poor is large and where the livelihood of a larger proportion is threatened regularly by natural disasters.

It is good to bring down the threshold in the interest of the large vulnerable sections of Indian population. Neither the Finance Minister nor the RBI can adopt an elitist stance in a poor country.

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