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RBI’s India Report Card: Alarming

Oct 22, 2001

The entire focus of economists, investors, bankers and the population of this country is typically on the change in CRR and or the change if any, in the Bank rate. These two changes signal the direction the RBI would like the economy to take. Lets take these two items a little later. Much more significant than these two numbers is the global report card presented by the RBI Governor and where India stands today which obviously is presented in more detail. The revelations are alarming.

The World’s ‘advanced’ economies are expected to grow at only 1.3% (GDP growth) over 3.8% last year. India will still maintain a growth rate of between 5% and 6% for year ended March 2002. But….

The gross fiscal deficit increased from 1.7% to 2.3% in the first 6 months itself. Upto October 20, 2001 (6.5 months) the government has already borrowed 86% of its entire budgeted borrowing program for the whole year! It has only 14% of its budgeted resources available for the remaining 45% of the financial year. Government profligacy at its best.

The Industrial Production growth rate has plummeted from 5.6% to 2.2%.

Performance of the key infrastructure industries index is a crucial barometer for measuring the economy’s growth and is a key stimulant for industrial activity. It comprises the electricity, steel, coal, cement, crude petroleum and refinery products. Industry uses electricity to drive machines. Coal, petroleum and refinery products to power furnaces, drive engines, etc., steel and cement are still the key raw materials for many manufacturing industries. Well, there is no good news. Last year the key infrastructure index grew by 6.9% and this year has collapsed to 1.2%.

There are other signs of the RBI’s concern when discussing the industrial sector. In a single paragraph the first four lines include the words – sombre, sluggish, subdued and depressed. So much for reading between the lines, its actually stated in plain English.

It has warned that the interest rate environment can change dramatically in a very short period of time. Over the last two years interest rates have remained weak. This has resulted in large gains for holders of medium and long term securities. They have warned that this is the time to build reserves to guard against any interest rate reversal. Simply put, for the investor with large exposures to Income Mutual Funds and Treasury Funds which are the flavour of the day – be very careful. In case of an upward turn in interest rates (as happened as recently as June/July 2000) there could be large capital losses since bond values will go down sharply. Your secure monthly/dividend could stop and when you exit you could be looking at an NAV that is so low you could have a capital loss on your hands. This has been coupled with a clear indication or call it a warning that a further reduction in interest rates in India seems very unlikely. Implication – be prepared for them to stay flat or go up but certainly not downwards.

Export growth is now non existent. From a growth of 21.9% last year, this first half has seen it turn to a negative –2.3%.

There is a small silver lining – foreign exchange reserves are up at US$ 45.1 billion, the south west monsoon has been good for a second year running, the north east monsoon is expected to be good and agricultural performance is encouraging. Unfortunately it stops here.

Thank you Mr Governor for a factual and thought provoking report card. For the sake of this country and its people one can only hope that the powers that be in Delhi hear this clarion call loud and clear. The glass is still half full or half empty depending how you look at it. A little over 5 months of this year are left. A lot can be done. The glass is still half full - let it not become empty.

The two items to be taken a little later – lets take these one by one:

  • CRR has been brought down by a “”whopping” 2% signalling larger funds being made available to the economy through the banking system. The impact of this 2% change is much less than it actually seems because augmentable lending resources of banks will increase only by Rs 6,000 crore. Compare this with the .5% cut in the rate on 12th May, 2001 which resulted in the lending resources increasing by Rs 4,500 crores. On a like to like basis the lendable resources should have increased to almost Rs 18,000 crores. But it hasn’t. Because the RBI has given away some money but has also taken back some. Net effect, rationalisation without any significant increase in money supply to a banking system already flush with money and no good borrowers whom it can lend to. Careful reading of the policy shows that all exemptions on other liabilities will be withdrawn. This reveals that the calculation of CRR itself has changed.

  • Decrease in Bank rate by .5% from 7% to 6.5% has signalled that the impetus to the economy that was required has been given. Money will probably become cheaper for borrowers. This cut means that banks borrowing their funds from RBI will now get a rate that is lower by .5%. Effectively you can expect to earn less on your bank savings account and on you bank deposits too.

For full coverage of the Monetary and Credit policy, please click here.

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