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Pushing Up Economy:BALANCING INFLATION AND GROWTH, by Dr. Vinod Mehta,27 October 2005 Print E-mail

Economic Highlights

New Delhi, 27 October 2005

Pushing Up Economy


By Dr. Vinod Mehta

The Reserve Bank of India has come out with its mid-term Review of Annual Policy for the year 2005-06, which endeavors to encourage the high growth rate and, at the same time, tries to control the rate of inflation.

The economy has been growing at a higher rate for the last two years. The manufacturing sector is on the high growth path and so also the Service sector. Only the agricultural sector had a dampening effect because of bad monsoon. Hopefully, the bad monsoon year is over and agricultural sector will perform well during the current agricultural year, which is from July-June.

On the inflation side prices of the petroleum products have been the major factor. Though the Finance Minister thinks the worst is over on the petroleum front, the RBI feels that the international prices of the petroleum products have now stabilized at a higher level and are unlikely to come down in the near future. They may remain volatile and so there will be a constant pressure on the price level.

It has already been reported that the growth rate during the first quarter of the current fiscal year has been around 8.1%.  Finance Minister is hopeful that he will be able to sustain it during the course of the full fiscal year. Therefore, the RBI while announcing its mid-term Review has been guided by two concerns – growth and inflation – and measures announced by it are designed to allow the economy to sustain this growth rate and at the same time contain the rate of inflation at around 5%. The RBI has not changed the CRR ratio but has raised the reverse repo-rate – the rate at which Central Bank borrows from the banks – by 25 basis point from 5% to 5.5%. 

The implication of this measure is that the interest rates, both on lending and deposit, will rise. This, however, does not indicate a very sharp hike in interest rates but moderate hike may be from ½% to 1% or may be up to 2%. Apart from it the RBI has also announced a number of measures which will have some impact on the banking sector.  For instance, banks’ direct capital market exposure has been raised to 20% of its network which means that the stronger banks can invest more in the stock market. The textile companies and infrastructure companies can now look for bank guarantee, which means that they will have access to funds at better rates.

At the same time the RBI is also worried a little bit over the housing loans which have been growing at a very fast pace in the past few years. With the hardening of the interest rates the interest rates on new housing loans are likely to go up marginally. It also means that those who had obtained loans on floating interest rates, for them also interest rates may go up. Similarly other types of consumer loans for the purchase of durable goods like TVs, cars etc. will also go up.

However, those who have been waiting for hike in the interest rates in banks’ fixed deposits may also find an increase in the interest rates in the coming months. Apart from changes in the interest rates there is a significant move on the part of the RBI to de-regulate the interest rates on savings bank deposits. At the moment the interest rate on savings bank deposit is 3.5%.

The Reserve Bank’s reading is that with the competition hotting up among the banks, the rate on interest on savings bank account will not go below 3.5% after de-regulation of the savings bank interest rates and in fact may go up. It will be recalled that the interest rates on the savings bank two years ago was fixed at 5%. Deregulation means that every bank can offer any rate of interest on savings bank account depending upon its financial health.

In this mid-term Review the RBI has also taken a step to bring more people to keep their money in the banks. It has suggested that the banks may introduce “no-frills” account where the minimum balance would be either zero or very low but the account holders will have to pay for the services like issuance of cheque books, ATM cards and also statement of account. Some of the new Indian private sector banks have already offered zero balance facility to many depositors. Now this measure will also be applicable to foreign banks operating in India.

Reacting to the midterm Review the Finance Ministry has stated that the hike in both the repo and the reverse repo rate by the RBI will not raise interest rates for investment in the economy but will curb inflation. The reason for the optimism is that there is adequate liquidity available in the economy, that is to say, the funds which are available for lending are available in large quantity. The funds to be made available to small and medium industries will also be doubled in the coming months. Moreover, it may be added that the interest rates on loans to stronger companies are always flexible and negotiable, so it is unlikely that the interest rates on loans to bigger companies will rise to any significant extent. The loan offtake will not go down, according to the Finance Ministry.

The other factor which the RBI has highlighted is that India’s current account deficit could be a cause of concern but manageable. India’s import to GDP ratio is on rise and it has risen to 17.2% in the first quarter of this fiscal year from 13% five years ago which is mainly due to increases in both oil and non-oil imports. Surplus in the capital account has, however, helped in easing the overall balance of payment situation.

At the time when the RBI was announcing its mid-term credit policy, Deputy Chairman of the Planning Commission, while delivering the Sardar Patel Memorial Lecture in New Delhi, made a significant statement that the economy was ready to transit from a phase of moderate growth to a new high growth stage where it may achieve an average growth rate of about 8% overt the next 15 years. But this calls for supportive action to make this growth rate attainable. He was particularly hinting at the increase in the FDI which at the moment is 1% of the GDP and could be increased further through appropriate measures.

The Deputy Chairman further observed that with population growth slowing down to about 1.5% over the next 15 years, an 8% growth in GDP means that per capita income will grow at about 6.5% per year instead of around 4% or so in the past 15 years. The faster growth in per capita income means that per capita income which increased by 80% over the past 15 years will increase by 160% over the next 15 years. This in other words means higher living standards for the people of India.

The RBI is doing its bit to push up the growth rate and curb inflation by way of monetary policy but it is the Finance Ministry which has to do its homework well to push up the growth rate to 8% and sustain it and at the same time curb the inflationary tendencies. The RBI has made the first move and now it is for the Finance Minister to make a major move by rationalizing the indirect tax structure.---INFA

(Copyright, India News and Feature Alliance)




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