A reduced fiscal deficit rather than the central bank’s monetary policy will have greater significance on bank lending rates.
Seeking to drive home this point to a gathering of industrialists here on Friday, Deputy Chairman of the Planning Commission Montek Singh Ahluwalia said blaming the Reserve Bank of India (RBI) and its interest rate policy was a “slightly over-simplified approach. I am not saying that’s [interest policy] not an important instrument, but availability of medium-term money at reasonable rates cannot be achieved simply by operating on the repo rate in the system. It is actually achieved by reducing the fiscal deficit.”
Mr. Ahluwalia, who was addressing a meeting organised by the Southern India Chamber of Commerce and Industry (SICCI), said in 2008, the combined fiscal deficit of the Centre and the State was about 4.7 per cent of GDP and private household saving, which went into the financial sector, was over 11 per cent, net of their own borrowing. In effect, 6.3 per cent of GDP was being intermediated in the financial system through household savings to the corporate sector.
Around 2011-12, the combined fiscal deficit was 8.1 per cent and the amount of household sector savings going into the corporate sector was less than one per cent. “Unlike in the U.S., the repo rate is not a rate at which RBI lends freely.” Whereas when the U.S. Fed reduces repo rate, it is willing to pump any amount of money into the system to ensure that is the market rate. In the case of RBI, that is not the case, because no bank would borrow from RBI short-term for three days and lend to someone for four years.
Mr. Ahluwalia said the need was to move in a concerted way in the next two to three years to reduce fiscal deficit, get rid of supply constraints, and solve the regulatory problems with infrastructure projects, most of all the fuel supply problems for the power sector.
“All these put together would enable the Indian economy to see an increase in investment, at the same time as being able to run a slightly elevated current account deficit for sometime.”
Noting that current account deficit (CAD) was high, he said a comfortable level of CAD would be 2.5 per cent. But it was also not “so difficult to bring it down if you are willing to kill the growth. The name of the game is how to bring down while keeping investment going.
“For that, it has to be brought down in a more gradual manner, and the only way we can do that if you can finance it, and financing it really means ensuring confidence in the economy.”
India, he added, was one of the few destinations in the world, in the medium-term, with possibility of high growth.
According to him, it is clear that in America and Europe interest rates are going to remain low as they are determined to keep the interest rates low in the hope to revive the economy.
“That created an environment where we would face globally a low interest rate situation, and if we could present the picture of an economy ready to grow, and the government could play a role in being decisive in the three or four areas that people are looking at then we should be able to attract funds [from U.S. and Europe].”