Economic Highlights

New Delhi, 30 July 2010

Inflation &RBI

PARALLEL ECONOMY CALLS  SHOTS

By Shivaji Sarkar

Inflation is rising and rising. The Rupee is not being allowed to be re-valued and the RBI is not changing its prescription. The Apex bank’s hackneyed approach of playing with CRR (cash reserve ratio) repo and reverse repo rates has not helped the economy for over a year.

The moot point: Is the parallel economy calling the shots?

In fact, the RBI prescription has added to the inflation by jacking up lending rates. It has also caused problem for the industry in getting easy credit. Tough policy measures like increasing repo and reverse rates are extreme measures to reduce liquidity. The RBI accepts “there is severe tightness in liquidity conditions”.

It blames the Central Government’s “sudden need and sharp increase in cash balances arising out of significantly higher mobilisation under telecom auctions of 3G and BWA”. This has robbed the commercial banks of all the cash that they had for financing the companies to fund the auctions. (We had expressed this apprehension earlier in this column).

Despite this admission, one wonders why the RBI has taken a step that is likely to be counter-productive. It makes lending expensive and does not help bring down prices. As interest rates firm up prices rise on all counts. The very premise the first quarter monetary policy is based on is incorrect.

It also raises a question. If liquidity is so low, credit difficult then why are the prices on the rise? It is simple logic. If liquidity – cash availability with people and industry – is less the market could not be expected to be buoyant. This should have led to the fall in demand and consequently growth should have been effected.

Official figures claim that growth prospects are upbeat despite a fall in factory production. It appears to be a miracle. Hopes are being raised but would that really materialise?

The RBI has been raising repo and reverse repo rates since April 2009. It has increased it by 50 basis points and also increased CRR by 25%. In simple terms, it has sucked all the money away from commercial banks to its own kitty to fund the Government deficit. Despite that, the impact on prices that was expected a year back is not being seen.

This raises a vital query The RBI is not acting in the best of its wisdom or worse, it is ignoring the obvious signs. If prices and demand are rising despite a lower liquidity, then where is the money coming from? Lack of liquidity should have led to either moderation of the market if it was all in positive direction or should have led to a depressed state of affairs. As per official statistics, this has not happened except in the housing sector.

Obviously, one needs to know from where the money is flowing into the market, which is experiencing over 10.5% wholesale price (WPI) inflation and over 17% food inflation. It is well known that much of the inflation is managed through hoarding of products, which requires constant fund flow, or in some cases owing to supply side pressures.

The RBI candidly admits, “The monetary policies may not be the most effective instrument to deal with supply side pressures on inflation”. Then why is it using the tools that are likely to create more problems and also would not address the basic question of tackling the liquidity flowing in from parallel sources – away from legal domain.

The Apex bank has estimates but keeps these close to its chest. Notwithstanding, the estimates available are ancient. Besides, the bank’s powers to tackle parallel sources are legally limited. But it has authority to suggest ways to check it. But it is a politically volatile issue.

Estimates of black money circulating in the economy have varied widely from time to time. In 1967-68, it was placed at Rs 3,034 crores. But by 1978-79, it had soared to Rs 46,867 crores, more than 15 times in just 12 years. Black money was estimated to be 9.5% of the GDP (Gross Domestic Produce) in 1967-68, rising to 49% in 1978-79 and 50.7% of the GDP in 1987-88. 

Last time the Union Government released an estimate was in 1983-1984, when the parallel economy was said to be Rs 31,000 crores ---37,000 crores big, about a fifth of the official economy then.

Today, the official economy is touching Rs 65 lakh crores. By the same formula the parallel economy should be at least Rs 13 lakh crores now. If the Rs 12 lakh crores Union Budget is taken as the unit it would amount to Rs 2.4 lakh crores. These are wild estimates and the size may be bigger. Since this parallel economy is ruling the roost, official measures bounded by several legalities clearly have their limitation in curbing prices.

Not only that. The generation of parallel money is not restricted to only the domestic sector nowadays. It has international dimensions and multi-national companies and mafia fuel it. A glimpse of this facet was available in the 26/11 Mumbai terror attack funding.

This apart, the food sector is apparently being largely managed by the non-official economy. With large clout it is dictating and manipulating the stocks, supply and prices. The official measures have little role in controlling or combating this. At least, it cannot be done by soft strokes.

For long the Central Government was expected to integrate this parallel sector with the official economy. Around 2002, it took steps for voluntary disclosures but this had limited effect. It exposed the need to take bolder and pragmatic initiatives including a relook at the direct taxation system. Alas, this has not happened.

If the nation expects the RBI to do all that requires a bold political initiative, it would be too naive. Particularly as some cosmetic measures that the RBI is empowered to take would never solve the problem.

Significantly, the country needs to study rotting of 35 million tonnes of foodgrain stocks in official warehouses and its likely links with the parallel economy marketers’. In many other areas too such linkages are obvious.

All in all, the growth projections are based on many infirmities linked to domestic and international scenarios. The International Monetary Fund’s (IMF) expectations that world economy would see a rebound led by emerging (small) economies is too optimistic. The sovereign debt issues in Dubai and Europe might stymie that.

Thus, expecting India to grow in isolation would be too much. But the country could if someone somewhere has the courage to take on and integrate the money flowing out of the official domain. Needless to say, a daunting task which cannot be left out for long. It is dangerous. ---- INFA

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