Eleventh hour pinch-hitting

K. T. Jagannathan
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ith the Manmohan Singh-led UPA (United Progressive Alliance) Government set to end its second innings next year, things have suddenly turned hectic. In a late evening action on Tuesday last, the government relaxed significantly the norms for foreign direct investment (FDI) in several areas, including the critical defence sector.

In his address at the annual meeting of the Associated Chambers of Commerce and Industry of India (Assocham) on Friday last, Prime Minister Manmohan Singh hinted at further reforms on the FDI front. Ironically, even as he was announcing FDI reforms, Posco and ArcelorMittal decided to pull out of their multi-billion dollar steel plant projects frustrated by indecision and slow pace of approvals.

A sense of urgency, nay desperation, came out clearly when Dr.Singh conceded that the 6.5 per cent economic growth targeted for 2013-14 would be missed. The GDP grew by 5 per cent in 2012-13, a decade low number. It grew at 6.2 per cent in 2011-12.

Full arsenal

A concerned Dr. Singh asserted that he would use all means available under his command to contain CAD (current account deficit) that stood at a record 4.8 per cent of GDP (gross domestic product) in 2012-13. The reform initiatives are sought to be pushed through on a fast-track basis by Dr. Singh’s Government at the fag-end of its second innings, brushing aside the rising wave of opposition protests. These measures will take a while to see benefits on the ground. What passes one’s comprehension is: Why did Dr. Singh and his team wait this long, and rush an avalanche of steps at the eleventh hour? Given its flip-flops on the policy front (especially the notorious retrospective taxation), it is doubtful if its fag-end pinch-hitting sort of actions will have any convincing effect on foreign investors who wish to partake in the India growth story.

Three strikes

The three critical components of the economy — oil, power and coal — are all mired in one controversy or the other. And, all of them together make life miserable not only for policy planners but also common citizens. This is precisely the reason why the twin deficits — current account deficit and fiscal deficit — are rearing their ugly heads, and have taken monstrous proportions. How do we put a lid on these two? That is easier said than done. The challenge lies in making people pay for the cost of a product or service, and forcing them to avoid conspicuous consumption (like buying gold). In the intervening ruckus, it appears, however, that the supply side of the economy has not commanded the requisite time, space, and energy from the fiscal bosses. All these are collectively damaging the India growth story.

Dr. Singh was once the captain of the country’s monetary decision-making body. As the skipper of India, more than anybody in the government, he seems to understand the predicament of the Governor of Reserve Bank of India. Not surprisingly, he sort of endorsed the apex bank’s efforts to fix the rupee volatility issue. While doing so, however, the Prime Minister expressed the optimism that the Reserve Bank of India would reverse its action once the rupee stabilised.

“The most immediate cause of worry is the recent volatility in the foreign exchange market,” he told the audience at the annual meeting of Assocham in New Delhi. The rupee swings have been hurting the cause of the Indian economy what with the country is hugely dependent on imports for its oil needs. The rising gold import has only helped to accentuate the misery.

Quick crunch

The past week was indeed eventful, as the RBI, to the surprise of many, hurried to tighten liquidity in the market. It increased the marginal standing facility rate to 10.25 per cent from 8.25 per cent. MSF was introduced in 2011-12 policy of the RBI to allow banks to borrow funds from it at 8.25 per cent, 100 basis points above the LAF (liquidity adjustment facility) repo rate.

As a result of this, the bank rate also stood adjusted to 10.25 per cent. The apex bank also announced open market sale of government bonds worth Rs.12,000 crore on July 18. Ostensibly, these measures were intended to stem the rupee slide by taking the speculative fizz out of the market.

It did have the desired effect, as it ended the rupee’s foray into 60s. However, these measures have brought more headaches to the monetary bosses, and triggered unintended consequences.

The RBI rejected all bids in the Rs.12,000-crore treasury bill sale on Wednesday. In Thursday’s bond sale (Rs.12,000 crore) in open market operations, the RBI could accept just a little over one-fifth of the bids. The RBI, however, managed to push through the issue of government bonds worth Rs.15,000 crore, with yields roughly 50 basis points higher than a week ago. The RBI had to encounter stiff demand from underwriters who sought hefty commissions.

Failed bid

Fearing that the liquidity tightening measures would have redemption pressures on mutual funds, the apex bank even opened a special repo window at an interest rate of 10.25 per cent for a total of Rs.25,000 crore. It, however, did not receive any bids. Cash-rich corporates appeared to have gone to the rescue of banks by picking up cheap units of liquid mutual fund schemes.

A significant fall-out of the RBI action in the past week is that the benchmark 10-year bond yield has risen. This is bound to seriously erode the efforts of the RBI to drain liquidity from the system. What does this portend? What will the apex bank do when it meets on July 30 for its monetary policy review?

The Prime Minister indicated that “these steps (RBI actions) are not meant to signal an increase in the long-term interest rate”.

Nevertheless, it is little risky to speculate on what the RBI will do in the evolving dynamic situation. While the RBI is expected to tread the line of caution, the government must indeed be worried.



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