Rbis Convertibility Headaches Build
The Reserve Bank of India (RBI) is likely to win more freedom to pursue inflation goals under a blueprint for rupee capital account convertibility, but analysts and bankers fear the central bank will get a raw deal.
Central bankers the world over would relish the chance to manage their currency and have a free hand to cool price pressuresbut India is different and inflation fighting needs more than a noose around money supply. Agricultural prices can swing with the monsoon, and state controlled prices of food, fuel and raw materials are bound to go up unless the government stops de-regulating. Inflation in India is not a monetary phenomenon, Mark McFarland, economist at Peregrine Brokerage Ltd in Hong Kong said.
He cited government borrowing and trade union power, fuelling wage inflation around 20 per cent, as other factors in the equation. The country has to drag its inflation rate down to G7 levels before risking floating the rupee, and the job will go to the RBI if recommendations made by the committee charged with plotting the route to convertibility are followed to the letter.The task does not appear too onerous given wholesale price index inflation is currently below six.
Fixing monetary growth targets cannot work alone, and even the central banks ability to steer interest rates is debatable. There is little the RBI can do about the size of the governments fiscal deficit and the upward pressure excessive government borrowing could put on interest rates bar loosening monetary growth targets.
The RBI cannot be responsible for what the government does, but it must take account of what it does, Rajan Govil, economist at HSBC B&K Securities, said. The federal government deficit, which was five per cent of gross domestic product in 1996-97 (April-March) and is targeted at 3per cent by 1999-2000, is only a part of the story. State government deficits, loss-making public sector units and a $4.3 billion oil pool deficit covering petroleum product subsidies are other factors which along with the central governments deficit account for nearly 10 per cent of gross domestic product. To ask the RBI to hit an inflation target without an assurance from government that it will cut its fiscal deficit is like tying one arm and one leg behind its back, said one senior manager at an international bank in Mumbai. India needs to get its fiscal house in order. With public sector debt running at 50 per cent of GDP, a debt trap of borrowing to pay interest lies in wait. The Tarapore committees proposal for a consolidated sinking fund to pay off debt is a second best option, McFarland said.
The government could offset the inflationary affects of shaving subsidies by progressively reducing import duties, but the loss in revenues will hamper deficit reduction efforts. The central bank will have to clear up the mess if finance minister P Chidambarams bold budget gamble on tax-cutting, supply-side economics falls short. Chidambaram lowered taxes to stimulate economic growth and induce more people in Indias large moonshine economy to join the legitimate taxpaying world in order to increase revenues.
If the revenues do not flow fast enough, the government will have to borrow to invest to keep the economy on course for seven plus growth or print money. Either way spells trouble entering capital account convertibility.