Economic Highlights

New Delhi, 28 May 2011

RBI Monetary Policy Fails

BLACK MONEY CALLS SHOTS!

By Shivaji Sarkar

Black money is increasing in the economy and the market is showing contradictions. Wherein currency notes in circulation have increased by over 21 per cent over the last one year but the stock market turnover has come down to single digit at 9.6 per cent. According to Reserve Bank (RBI) date, in absolute terms currency notes circulation has risen from Rs 786,266 crore as on 30 April 2010 to Rs 952,604 crore on 30 April 2011. An increase of Rs 165,438 crore.

Significantly, this is against the tight banking and monetary systems introduced by the RBI during the last over 18 months. In theory, tight banking is anti-inflationary, which should have helped RBI contain inflation and money circulation. But inflation is rising, both at the wholesale and retail levels and has brought the economy to a critical point.

Clearly, the increase in black money in the economy has led to money circulation going up. Perhaps, the reason for the real estate maintaining high speculative prices despite not having a happy sales turnover.

This, however, has hit the stock markets. Whereby, tightening of regulations has led to legal money supply being on leash. But this is not to state that stock markets are propelled by white money alone. The post-2-G scenario has definitely put a brake on black money flow to a market that is on a continuous scanner.

The excess notes in circulation could be defined as money gone out of the banking system which is now circulating as cash. This is the characteristic of the Indian economy. A lot of cash is used in the country for transactions instead of debit-credit cards or other modes of banking transactions.

This is in contrast to Western economies where debit and credit card usage is high and money stays within the banking system. It is untrue to state that it does not have a skewed monetary system. Indeed, the 2007-08 Lehman Brothers-led crises was due to that, leading to collapse of a chain of monetary institutions.

India too has witnessed such scenes repeatedly since the 1992 Harshad Mehta scam, UTI bust and Ketan Parekh scandal, to name a few. Still a major corporate house is facing a SEBI ban on stock market transactions. The SEBI itself is under scanner.

So despite a large money supply, the market is gripped by fear. Investors with large cash are shying away from investing in scrips. As a percentage of total volumes, the average daily turnover in the cash segment of the stock market has dropped. The average in the last quarter, before further RBI tightening in April was 14 per February 2009, when it plunged to Rs 10743 crore.

Importantly, there has been a steady decline over the last few months. In October-December 2010, the average daily volumes were Rs 21,000 crore, which plunged to Rs 16,000 crore during January-March. With foreign institutional investors (FII) selling continuously throughout May, in the wake of the crisis in the European region and partial recovery of the US market, retail investors’ participation is not there and those engaged in intra-day trading have also not made money.

A shift has also been noticed. Many of the short-term traders have started engaging in commodity markets. This is a significant development and indicates that black money is playing a role in commodity transaction. It helps keep prices remain at a high, commodities are easier to hoard and prices easy to manipulate. This is evident as prices of food grains, butter, milk, fruits and vegetable are breaking all records.

Hoarders are known to use black money for commodity trading in a large scale. Thus, monetary tightening has little impact on the inflationary trend. But it is impacting other sectors as well.  Be it industry or manufacturing are squeezed between inflation and monetary tightening.

Not only that. The high food prices are leading to higher operational costs as wages and transportation costs go up. The squeeze on money supply makes investments expensive and impacts pricing and leads to a fall in demand. Bluntly, growth is being seen in those sections of the economy that are seeing inflow of black money or where money has gone out of the banking system and is circulating as cash.

Undoubtedly, real estate is a major beneficiary of black money. Given that most of the real estate transactions involve a huge component of cash. Leading to not only property prices increasing by over 25 to 30 per cent over the last three years but the value of cash element has also gone up. This is one factor behind the increase of currency in circulation.

Moreover, the RBI’s tight monetary policy is failing also for the “gold for loan” scheme it introduced. With gold prices rising many are pledging gold and taking loans to buy consumer durables or invest in real estate. Since gold loans are usually given in cash, this virtually facilitates cash to be used for many operations that may not be considered strictly legal.

Needless to say, the contradictions need to be studied closely as it is affecting growth of all sectors. If the trend is not checked, it might lead to a dismal economic scenario. Whereby, the Government’s fiscal deficit is bound to rise. It might lead to a cut in developmental expenditure, which may further affect the growth prospects.

Already in the last quarter, the 2010-11 GDP growth is estimated to have fallen. With the situation in the US, Europe and northern Africa being in turmoil coupled with India’s investment climate subdued, the 2011-12 growth prospects is likely to be shaky.

Plainly, it calls for a change in lowering of interest rates and tightening of the commodity market system to give a boost to the economy and check prices. The first, deciding policy rates, is in the RBI’s domain but tightening the commodity market system needs brain-racking as it is out of the legal framework purview.

Additionally, many individuals and corporates are basking in the system that favours them. Specially, as both have black money for operations. Thus, till such time that all money is scanned financial manipulations would be the norm. Whereby, banks would be at the mercy of the unscrupulous and the economy despite Government promises might remain off the hook. ---- INFA

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