We are paying dearly for ignoring savers
While India is facing a macroeconomic disorder, it should not be made the playing field for political scoring points. Of course, we can blame the global economy for all our problems, but we need to undertake a serious introspection of our problems which would lead us to appropriate solutions.
Neglect of savings
The root cause of our problem is that for the past 15 years, we have drastically reduced incentives for savings. After years of heady GDP growth of 8-9 per cent, we are down to a growth rate of 5 per cent. While we used to pride ourselves for having one of the lowest inflation rates in the Emerging Market Economies (EMEs), we are now burdened with the ignominy of one of the highest retail inflation rates (10 per cent). The overvalued rupee exchange rate is wobbling and holding up only because it is on the ventilator. The coup de grace is the balance of payments current account deficit (CAD), which is critically high, at 4.8 per cent of the GDP in 2012-13, whose correction is the topmost priority.
Comparisons with 1990-91 are odious
In 1990-91, our foreign currency assets had been wiped out and we had to sell our gold. In contrast, the problem today is of a very different genre. We are, now, for all practical purposes, an open economy, and although we have forex reserves of US $280 billion, we are dependent on very large volatile capital inflows-Foreign Institutional Investors(FII), External Commercial Borrowing (ECB) and Non-Resident Indian (NRI) deposits. As such, we cannot be complacent as during the course of the next 9-12 months, there could be a very large exodus of foreign capital out of the EMEs and India, with its very large CAD, is most vulnerable.
Obverse of savings-investment gap
There is an identity, written in stone, that the CAD, presently 4.8 per cent of the GDP, is nothing other than the gap in 2011-12 between gross domestic savings (30.8 per cent of GDP) and gross capital formation (35.5 per cent). Regular readers will excuse the present columnist repeating, ad nauseam, this simple identity, as our philosophical moorings are that if interest rates are low, investments will rise, and with the resultant growth, the gap between savings and investments would disappear. It is this fundamental flaw in mainstream thinking, which has resulted in the policy of not adequately rewarding savings.
System is against savers
A feature of India has all along been that savings are high and the bulk comes from the household sector. In the eagerness to please investors, interest rates on savings instruments have been brought down in nominal terms, despite retail inflation rising to double digits. Moreover, tax concessions are biased against savings in deposits and other debt instruments and unconscionably biased in favour of equity investments - witness the unlimited income tax exemption for dividends. High inflation is a disincentive for financial savings. It makes sense for savers to move out of financial assets to physical assets, such as real estate and gold. Mere exhortations by the authorities to savers to stay away from gold and real estate cannot be effective.
Constraints on effective policy
The government is hemmed in by political economy constraints, at least till May 2014, which do not enable any corrective measures to be taken, such as raising taxes or drastically cutting subsidies. These are not unique problems, as all governments face these problems. The experience of the past 50 years has been that when the government is constrained in taking effective measures, it has encouraged the Reserve Bank of India (RBI) to undertake effective monetary policy measures to attain specific objectives.
Broad guidance to the RBI
The government should give 'closed door' guidance to the RBI to use all its instruments, without constraints, to ensure that the Consumer Price Index (CPI) inflation comes down from 10 per cent to 5 per cent by early 2014. Again, the RBI needs to be assured that it need not expend its forex reserves in defence of a particular exchange rate. Furthermore, it should not shore up the rupee on the pretext that it is controlling volatility. It needs to be recognised that a massive outflow of capital from the EMEs is inevitable in the next 9-12 months and India should conserve its forex reserves. What is important is that the topmost policy decision-takers should silence their guns attacking RBI policies. When the RBI took measures on July 15, 2013, the government immediately said that this did not portend monetary tightening!
RBI measures on July 30, 2013
For the July 30, 2013 policy, the RBI needs to build on its measures of July 15 and July 23, 2013. The RBI should give an unequivocal signal of monetary tightening. The ingredients of the policy could be as follows:
(i)The repo rate at which banks borrow from the RBI against the collateral of government securities, should be raised by 0.50 percentage points from 7.25 per cent to 7.75 per cent; this is necessary as the access under the Liquidity Adjustment Facility (LAF) has been curtailed from Rs 75,000 crore to Rs 37,500 crore
(ii) The cash reserve ratio (CRR), under which a proportion of banks' cash is impounded by the RBI, should be raised from 4.0 per cent to 4.5 per cent. This will impound Rs 35,000 crore.
(iii) The RBI should undertake small open market operation (OMO) sales of securities on tap (i.e. offering to sell securities at a certain price), which would raise yields on new floatations; the government has to make this sacrifice.
(iv) The RBI should continue to be in a tightening mode till retail inflation comes down to 5 per cent.
Impact on deposit rates
Depositors have been the whipping boy for many years. The backlash of this has been the fall in financial savings. The above measures would force banks to raise deposit rates. This would be the first tiny step towards rectifying the bias against savers.
Will the government agree to take a hands-off approach on monetary policy? Will government agree to a gradual increase in the cost of government borrowing? Sadly, the answer to both these questions is an unequivocal 'no'. The upshot of all this is that retail inflation will remain high and the CAD will remain unsustainable and growth will languish. I fervently hope I am totally wrong. While we can always blame the global economy, we need to recall "The fault, dear Brutus, is not in our stars, but in ourselves that we are underlings" (Julius Caesar).
Please Note: This article was first published in The Free Press Journal on July 29, 2013. Syndicated.
This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.
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