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Recovery Fragile:RBI PREPARES FOR MORE SHOCKS, by Shivaji Sarkar, 30 October 2009 Print E-mail

Economic Highlights

New Delhi, 30 October 2009

Recovery Fragile

RBI PREPARES FOR MORE SHOCKS

By Shivaji Sarkar

It’s an awkward situation. The doctor has a diagnosis but his prescription does not treat the symptoms. This is what the Reserve Bank of India has done in its latest review of the economy. Its diagnosis, however, has little to cheer the nation. The Central bank Governor, D Subba Rao, says, “The recovery is fragile, inflation is to touch 6.5 per cent by March 2010, private demand has yet to pick up and services sector is performing below the expectations.”

The RBI has not made any change in the growth forecast. It continues to peg it at 6 per cent and it appears that it still conforms to its earlier projection of 5.75 per cent. Though Rao does not say more but his actions indicate that he apprehends a serious crisis. Officially except increasing the statutory liquidity ratio (SLR) - the percentage of deposits that banks are required to invest in government debt - to 25 per cent from the existing 24 per cent he has done little.

In fact, it is a more cosmetic prescription as most of the banks are maintaining a higher SLR at 27 per cent. It is, however, a signal that the Government is short of funds and its revenue generation is not matching its demands. This is a sign that the Government would be borrowing more to sustain its budget projections. The rise in SLR is a step backward leading to the pre-reform age, when banks were forced to finance large government deficits. “It is reversal of an exceptional measure,” says Subba Rao. This is an indication that 2010 may not be as bright as it is being projected. The RBI stress on tightening the screws, to prevent an impending financial crisis, is a grim pointer.

In its concern the Central bank withdrew a special facility that made funds available from banks to mutual funds and finance companies, made loans to commercial real estate more expensive and forced banks to invest more in Government bonds. The special facility was introduced last year to boost liquidity to the financial sector firms after the credit market froze. It also means squeezing the funding process that ultimately leads to speculative activities in the stock market and the real estate. It should be seen as a warning and signals distrust in the stock market functions and the real estate.

It is also a reversal of the policy from providing stimulus to checking money supply so that inflation could be controlled. In other words it could be said that the course of debate on economic stimulus has been shifted from boosting growth to controlling inflation or managing inflationary expectations.

In doing all this, the Central bank admitted that bank credit remained sluggish, which is at 10.8 per cent now, and cut its forecast for adjusted non-food credit growth in 2009-10 to 18 per cent from 20 per cent. Non-food credit is a euphemism for the credit off take by the industry, manufacturing and related sectors. This indicates that actual activities at most levels have come to the minimum and there is little hope of recovery in the near future. This possibly explains why Subba Rao calls the recovery or growth “fragile”.

The RBI has reason to be alarmed with the rise in prices of all assets - real estate, equities, gold and commodities. The equity prices have risen by 75 per cent surprisingly in an economy that has remained sluggish.

A 43 per cent year-on year growth in bank lending to real estate at the end of August had already sparked speculation that the RBI might act on these loans. The real estate prices spurted on easy funding and this had to be curbed. The step would be welcome by all who are being fleeced by the real estate sector but it does not give solace to over 30 million people who do not own a dwelling unit. The real estate sharks so have not been contained but the poor seekers of a hue are the worst sufferers. The Central bank with its flip flop policies has not been able to bring any succour to them. Its prescription of raising interest rates and squeezing credit has not hit those it had aimed at. It has not yet ushered in a regime of quality credit - proper appraisal of assets and the commercial sellers.

It is difficult to understand why it does not empower and also make it mandatory for the banks to scrutinize the housing pricing system. The banks have little say on the housing prices but they are expected to fund a sector managed largely by rogue companies. The present prescription is also not expected to hit them. Therefore, it calls for a strong instruction to deal with these elements and not come out with mere showpieces as the RBI is doing repeatedly.

Despite some improvement in the rise of the index of industrial production (IIP) at 5.8 per cent compared to 0.6 per cent growth in 2008-09, it is not being considered as very positive. Intermediate and consumer durable goods sectors witnessed higher growth but the performance of capital goods and consumer non-durable goods was relatively modest.

The biggest concern is on the agricultural front. Fears have been expressed because deficient rainfall might cause disproportionate impact on overall economic prospects and on the sense of well being. “Poor output”, says the Central banks “is bound to push up prices and depress rural labour incomes. Given the inter-sectoral supply-demand linkages, the knock-on impact on the industrial and services sector can also be significant".

Except expressing concern, the Central bank has not come out with a viable solution to push the economy up. Going by its reservations, it seems the country is in for many more shocks. ---INFA

(Copyright, India News and Feature Alliance)

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