The Hindu Business Line : RBI worried too

More often than not, the Reserve Bank of India Annual Reports are nothing more than a summing up of the central bank's policies in the year under review and an overall perspective on the economy. The latest RBI Report for 2005-06 would, therefore, appear par for the course were it not for the differences within the government over two key policy issues. Over the past fortnight, differences between the Finance and Commerce Ministries have surfaced over the revenue implications of the privileges accorded to the Special Economic Zones under the SEZ Act, 2005.

In a parallel development, North Block finds itself ranged against the Human Resource Development Ministry and, to a lesser extent, the Planning Commission over the importance of adhering to the fiscal deficit target. While the Finance Ministry would like to maintain its budgeted promise of fiscal prudence, the latter two would like the focus to be shifted to resources for Plan programmes. Against this backdrop, the RBI Annual Report is significant because it reflects the central bank's commitment to the Finance Ministry view on both the SEZs and fiscal prudence. The RBI is concerned that the SEZs could divert resources from less developed areas as also over the possible revenue losses should the SEZs fail to "ensure forward and backward linkages with the domestic economy." As for government expenditure, the RBI claims that the fiscal and primary deficit were well within the prescribed limits and is confident that despite the higher allocations for the social sector, the deficit will not go beyond the cap. That sounds a trifle over-confident as in the first quarter itself, the Government crossed half the level of the fiscal deficit estimated for the entire year. Populism may yet win over North Block's commitment to fiscal prudence if the current differences over spending on Plan projects are any indication.

The Annual Report is also significant for the RBI's take on inflation. The headline inflation rate, as measured by the Wholesale Price Index, is supposedly steady at around 4 per cent. But this does not capture the reality on the ground; prices of primary products, particularly foodgrains and edible oils, are spiralling even as services — which the wholesale price index does not capture at all — such as medical care and transportation, are becoming costlier. The RBI's repo rate hikes have not been able to control these prices. Nor have lending rate hikes by banks curbed credit offtake so far. All that the central bank has achieved is to enable banks retain their margins. The irony is that the RBI's analysis shows inflation to be a result of scarcity and not excess demand. North Block and other ministries should address the supply-side problems if the near term economic outlook, which the RBI considers bright, is to stay that way.

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