The Annual Report for 2011-12, a statutory report of the Reserve Bank of India’s central board, covers two broad areas: the working and operations of the central bank and its financial accounts for the year and the assessment of the macroeconomic performance during the year and the prospects for 2012-13.

In 2011-12, the balance sheet of the RBI increased significantly by about 22 per cent, mainly due to open market purchases of securities, and the gross income by 43.4 per cent.

While income from foreign assets continued to decline for the third year in a row, earnings from domestic assets more than made up for the shortfall. The surplus profit transferred to the Central Government at Rs.16,010 crore was almost Rs.1,000 crore higher than in 2010-11.

Amid serious signs of a slowdown and the alleged role of the monetary policy in hampering growth, the RBI’s views are naturally relevant. The RBI says that several other factors combined with monetary tightening contributed to the slowdown. The report says that interest rates during 2011-12 might have impacted inflation but they are clearly not the primary reason for the downturn. Weighted average lending rates, net of inflation, were 3.8 per cent in 2011-12, far lower than the average of about 7 per cent in the pre-crisis period of 2003-04 to 2007-08 when investment had zoomed.

This explanation will naturally not go down well with the several advocates of a softer interest rate regime. However, for all its unequivocal statement, the RBI is most probably not revealing its monetary policy stance. In other words, whether there will be an interest-rate cut or not, the ensuing credit policy review will continue to be a matter for debate, with both sides marshalling their facts and figures. But the RBI’s assertion that high interest rates are not the only, or even the main cause for the slowdown, gives a new twist to the traditional monetary policy debate of growth versus inflation. If interest rates have not made such a significant impact on the growth process (at least in the pre-crisis period), is it possible for the monetary policy to simultaneously take care of growth and price stability? Obviously, the answers will not be clear-cut. Among other factors influencing the debate, inflation expectations play an important part. The belief that high interest rates are well entrenched and cannot be brought down easily will result in inflation remaining high. As far as RBI policy reviews are concerned, there will not be a radical change in the approach to growth versus price stability. It will certainly vary the emphasis depending on the macro factors at the given point in time.

During 2011-12, growth decelerated to below the economy’s potential due to global and domestic factors. Inflation persisting at high levels and widening twin deficits constrained the RBI’s scope for countercyclical measures.

Weak outlook

Growth in 2012-13 is expected to stay at around the previous year’s level of 6.5 per cent. Factors that held back growth last year remain and show no signs of abating. New uncertainties have emerged in the form of unsatisfactory monsoons.

Since no improvement in the global scenario is likely in the short-term, the problem of adjustment will have to be borne by domestic policies. There is very limited monetary and fiscal space to provide a direct stimulus. The RBI, therefore, harps back on the difficult-to-implement suggestion to pare subsidies and use the released money to step up capital spending. Inflation is expected to remain sticky at around 7 per cent. Upside risks include deficient monsoons, large upward revision in the minimum support prices and exchange rate depreciation.

Stressing the need to address twin deficits to contain risks to macroeconomic stability, the RBI feels that they are likely to remain wide during this year in the absence of adequate policy response and no improvement in business cycle conditions. With growth slowing, the pressure on the fisc will increase. Consequently, some level of slippage becomes unavoidable. This, in turn, could crowd out private investment at a time when reviving investment, both public and private, is critical. This could, through higher aggregate demand, then spill over into higher inflation and wider current account deficit.

The overall CAD-GDP ratio may not correct significantly this year. Net services exports are down. It is important to reduce CAD to manageable levels. The resort to short-term debt flows to partially bridge CAD has some long-term costs in terms of sustainability of such funds and refinancing risks.

Neither the above near-term dissertation of the economy nor the medium-term challenges listed out separately is new. Yet, the value of the RBI’s Annual Report is in no way diminished.

The supplementary issues that the RBI raises as for example the decline in financial savings are extremely relevant at the current juncture.

narasimhan.crl@thehindu.co.in

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