Dr. Rakesh Mohan, Dy. Governor RBI, had a quick chat with Equitymaster post the Union Budget 2003-04. He gave his views on the budget, guaranteed pensions, bonds buyback and finally his outlook on inflation. Read on…
EQTM: Sir what’s your reaction on the budget?
Dr. Mohan: Well basically this budget is very clearly giving a signal that the government is taking a better look, and the economic survey has given that indication. Basically we are observing an industrial recovery. What we need to do is further encourage this recovery. I think from that viewpoint this budget is consistent. The budget has focused on certain infrastructure sectors and is learning the lessons from the national highway development program. Therefore now there are more specific investments in railways, airports and ports. Also there is a larger effort to involve the private sector in the infrastructure development. The cess of diesel and petrol has been increased and will help finance the expanded road program.
In this respect, the sensible point being made here is that the government is not trying to reduce the fiscal deficit at the expense of planned expenditure, keeping in mind the focus of expenditure on growth-inducing activities. The budget has also highlighted the need for a social security and pension scheme that the LIC has come up with. The government has also made it clear that the liability that LIC incurs in order to give the 9% returns will be compensated by it. Then there is the health insurance scheme, which I think is a response to the general observation that healthcare has really become expensive. This is also acknowledging that more and more people are requiring higher cost treatment.
The budget also focuses on certain sectors like a new package for textiles sector. This package involves issues like import duties of capital goods for textiles. So, a number of consistent measures have been taken, keeping in mind the WTO deadline of 2005. So the idea is to give a modernization impetus to the textiles sector for them to compete better. Part of this was done last year and it is going much further this year and is more consistent than last year.
The budget has also recognized the strength of the IT industry, and has also given a clear signal on the tourism industry because tourism activity is employment inducing. There has been a lot selectivity, i.e., focusing on a few issues and sectors. I think that points to a slightly different strategy than previous budgets, which dealt with macro issues, addressing issues across the board. This budget is more focused and is taking bets on very clearly identified activities.
And of course, the third rate cut in administered interest rates reiterating the soft interest rate regime being pursued by the government. This is in view of the fact that despite the drastic fall in yields the lending rates have been high. All of this is geared towards facilitating a lower lending rate scenario. This is in recognition of the fact that India is persistent in limiting its interest rates in small savings schemes and agricultural PLR. Again everything is geared in the direction of growth.
EQTM: Coming to the LIC’s new proposed scheme. The government is going to bridge the shortfall that LIC incurs in providing a 9% rate of return. Don’t you feel that this is a retrograde step, going back from the government’s stated decision to do away with open-ended guarantees?
Dr. Mohan: I think there are different ways of looking at that. Yes, obviously this will come from the budget. It will involve higher tax revenues from the tax payer. But on the other hand if you do not have it, where can a person pay and get a certain amount of returns. Here we are giving an opportunity for the people to save, taking a certain large proportion from the market. Its also like a public private partnership where 90% is taken from the markets, as the LIC will get that from the returns and then topping it up with government support. This measure is giving instruments to people to save and demand their own pension. This they never had earlier.
EQTM: Does this scheme not give an implicit guarantee that the government will bail out LIC in case of any default? Why should this new scheme be any different from the pension schemes from the private players where the returns are market determined?
Dr. Mohan: This is a conscious decision by the government that this is a social security measure and that the government is willing to utilize budget money to top it up. And who knows, private parties may now give better returns seeing this. If the private parties are ready to give you a higher return, then it is your decision to choose. It’s a call you have to make.
EQTM: What is your outlook on the inflation rate especially since it has been increasing steadily?
Dr. Mohan: If you look at the numbers closely we find that there is not much of an increase in inflation. If you look at the WPI levels they have not increased much in the last 2-3 months. Very clearly the impact of rising oil prices will be felt, but if you look at the increases in oil prices and compare with the increases in domestic oil prices the effect is not much. What I mean to say is that if you look at the rise in domestic oil prices, you will see that they have not impacted the inflation significantly.
EQTM: Is the concern regarding the drop in agricultural output being underplayed?
Dr. Mohan: Certainly the magnitude of the drought will affect the demand for industry, but it is not as much as what was before as the proportion of agriculture contribution to GDP has reduced and continues to do so.
EQTM: Can you tell us how the buyback of bonds is likely to help banks?
Dr. Mohan: With the passing of the Securitisation Act, banks can now transfer their assets to an Asset Reconstruction Company in order to lower NPAs of the banks. But if the banks do that, then they have to take losses on whatever prices they transfer the asset to the ARC. So the idea is that currently banks are holding a large number of G-Secs, which have high coupon rates and a good number of these are illiquid. If they were liquid then banks could have booked gains on them and made provisioning for NPAs using these gains. Due to the illiquid nature of a part of the bank portfolio they cannot take advantage of the current low yields and book gains. Due to this we are ready to buy these illiquid securities from them. And if banks choose this option then we will be ready to give banks tax benefits as long as they use these gains for provisioning for NPAs.
So banks will be in a position to get rid of NPAs and they will be able to do that while increasing profits and at the same time get tax benefits. So over all their balance sheets are strengthened. So in the future banks can operate more efficiently. Also, one of the reasons for the higher lending rates of banks is the implicit cost of the NPAs. So it depends on the extent these banks have illiquid securities, based on which this whole exercise can take place. I would also like to emphasise that this will be a voluntary action by banks.