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The common man's macroeconomic worries - Outside View by S.S. TARAPORE
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The common man's macroeconomic worries
Nov 30, 2015

With the Reserve Bank of India (RBI) monetary policy review due on December 1, 2015, the common person has a number of worries regarding the macroeconomic situation. One fervently hopes that these fears do not materialise into an adverse backlash on the common person.

Seventh Pay Commission Award

The Seventh Pay Commission Award would cost a little over Rs 100,000 crore. Since this is a once-in-ten-years award, it is not that this should be denied to the beneficiaries. One, however, wonders as to how this would be funded. Would the fiscal deficit be allowed to increase or will other expenditure be reduced or revenue receipts increased? Hopefully, it would be a combination of all three alternatives. One would not be too sanguine that the impact would be a strong increase in demand and therefore be a boost for sluggish industrial growth.

Inflation Growth Trade-Off

By all counts the overall growth rate of the economy in 2015-16 would be in the 7.2-7.5 range. India's growth rate is the highest in the world. The danger is that intoxicated by success, we overextend ourselves. Niti Ayog Vice Chairman Dr.Arvind Panagariya has expressed the hope that perhaps by the last year of the present government's term, India would attain the much illusive magical 10 per cent growth rate. While these are legitimate aspirations, it is not clear whether the additional savings would be forthcoming. Expecting the higher growth to come out entirely from more efficient use of capital is a tenuous proposition.

Our past experience is that on many occasions, when there is an overextension of output it results in a downturn. One fully appreciates that one has to be positive in one's aspirations but when what we attempt to achieve is clearly beyond our reach, we enter the dangerous territory of the trade-off between growth and inflation which typically invites a sharp downturn in growth. It would be prudent to take a leaf out of the Chinese approach of being content with a slightly lower rate of growth while the economy is consolidating.

The biggest fear for the common person is a resurgence of inflation. The common person has no defenses against inflation. As it is, the year-on-year inflation rate is 5 per cent and it would not take much for inflation to accelerate. The unprecedented increase in prices of pulses imposes a cruel burden on the common person especially as, with a young and growing population, a protein deficiency is a serious health hazard. Hence, low inflation is an overriding priority in the Indian economy.

RBI Policy Interest Rate

Hopefully, this time around, the RBI is not going to oblige the voices clamouring for a reduction in policy interest rates. More importantly, given the secular inflation rate, it would only be prudent if the authorities recognise that we have come to the end of the interest rate reduction cycle. There are a number of reasons for coming to this conclusion.

First, unlike other countries, India is heavily dependent on the household sector for garnering savings and this sector needs some incentive to channel their meagre resources to financial savings. In particular, if bank deposit interest rates fall any further there could be a move into undesirable and unsafe financial products as also physical savings.

Secondly, there is no social security worth the name for the bulk of the population, particularly senior citizens. Thirdly, there already are pressures to reduce the small savings/post office interest rates. In the unlikely event of the RBI policy interest rates dropping further on December 1, 2015, savers would be well advised to migrate from banks to the Post Office and other savings scheme. Fourthly, the provident funds offer some comfort to small savers as collective bargaining power would help savers resist interest rate cuts on such instruments. Fifthly, with the strong possibility of the US Fed raising its policy signaling interest rate in December 2015, India would do well to refrain from any further reduction in policy interest rates on December 1, 2015.

India's competitiveness in global markets

Over the medium-term, Indian exports, particularly by micro, small and medium enterprises, are virtually being driven out of foreign markets. The 3 per cent interest subsidy on export credit is no compensation for an incorrect exchange rate. There is a strong case for gently letting the rupee drift downwards. Exchange rates which are misaligned damage an economy much more than other inappropriate policies.

Further thoughts on gold

The previous article had examined the three gold schemes. The article had suggested that savers would do well to opt for the Gold Bond Scheme.

The Gold Bond Scheme closed on November 20, 2015 and the commitment was that the allocations would be completed by November 26, 2015. It is now argued that with the large number of applications, it will take time to complete the allocation process which will now take till November 30, 2015. Only Rs 150-crore has been collected- this should not be construed as a failure of the scheme as there is a need for time for banks and agents to canvas for these bonds. This is not an instrument which you switch on and off.

As already suggested earlier, this Bond should be put on Tap. If the government really wants to make a significant dent with this scheme, the interest rate should match the Savings Banks' 4 per cent rate. If this is done it would be a roaring success. Of course there would be a cost but the cost is worth paying to wean investors away from gold imports. As the French say, "you can't make an omelette without breaking an egg".

Please Note: This article was first published in The Freepress Journal on November 30, 2015. 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.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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