By Anjan Roy
Two major policy statements which were presented in the last two weeks, the union budget and the post-budget monetary policy, have kicked up debates among economists and concerned public about the risks that the policy stances underwriting. These are mainly risk of a fiscal flare-up and run-away inflation.
Not entirely unexpected or unwelcome either. Such debates help in sharpening thinking about economic policy objectives and fine tuning of the available instruments for achieving these targets. Let we take a look into these debates flaring up just about at all turns.
Nor such differences unique now. We has earlier witnessed deep divergences in opinion and policy formulation between the government and the Reserve bank.
Reserve Bank of India’s monetary policy, announced on Thursday, has obviously been aligned to the stance taken in the union budget placed just over a week back.
Both the union budget and the monetary policy places high priority on repairing the economy and encouraging growth over a more cautious policy of fiscal puritanism and inflation targeting.
This stance has given rise to controversies on their wisdom, that is, whether a strategy for launching large infrastructure projects and spending money is really gong to initiate a virtual cycles of more employment, more income creation and more demand to lift the economy out of the present low growth top.
Similarly, in case of the monetary policy stance of carrying on with a low interest regime for encouraging credit growth, investment and consequent employment and income would, it has been argued by the conservatives, push up the price line. Here the critics of the monetary policy are accusing the Reserve Bank of turning a Nelson’s eye to the already potent inflationary pressures.
There have been some technical objections to the budget stance, arguing that a fiscal stimulus of the kind can work only in specific conditions an particularly when the debt to GDP ratios are low. With rising debt-GDP ratio, the effective of such a policy of more sending (obviously borrowed money) should raise employment and income or it will simply raise the price pressure.
But, there are reasons to believe that at the present moment the budget stance of spending through a crisis, as has been the economic orthodoxy for sometime, is not misplaced. A large infrastructure project like laying new roads or building bridges could immediately give employment to people at the ground level.
It is these people who have the highest propensity to consume, that is, a tendency to spend money when they get some income, and that is the sure shot for pulling the economy up. A spending of this kind would give income to unskilled workers some income. This is at least better than getting some marginal income from 100-days work under MNREGA.
In fact, last year during the peak of the pandemic, the government had stepped up the anti-poverty programmes and in response to demand for work under the MNREGA. These work necessarily do not create fresh social capital and therefore potential for future growth.
But most of these programmes and others offering income and some social security have been funded through additional borrowing. These obviously have added to the government’s deficit, mostly funded by the RBI. These programmes on borrowed money obvisoyl add to liquidity in the system and thus create conditions for stepped up inflationary pressure.
Now the question is whether the government and the RBI should at this point of time have undertaken a corrective measure of unwinding he deficit and borrowing programmes and introduced a “normalisation” programme.
That would obviously mean trimming the deficit by the government and lowering expenditure to start walking towards achieving a more balanced and safe fiscal profile.
For the Reserve Bank, given the huge liquidity overhang in the system and rising price line, should have started unwilling its expansionary policy and slowly increase the interest rate a tad bit to bring down the inflationary pressure. The RBI should also have started mopping up some of the excess liquidity in the financial system towards the same objective.
Neither the government nor the RBI have initiated the corrective economic programmes and instead embarked upon an expansionary cycle hoping to promote the growth triggers in the economy. They expect the large scale spending and an accommodative credit policy stance should encourage employment and employment creation. Therefore there will be more demand in the economy.
This is a rather happy situation between the North Block and Mint Street, which has been berated by some commentators. They feel the RBI should have raised interest rates and the government desisted from an expansionary cycle and launched a kind of fiscal correction.
This is a “politically correct” stance of the monetary policy in relation to the union budget, though there have been occasions in the past when the government and the RBI had differed wildly in their assessment of the Indian economy and therefore the policy prescriptions.
Spoilsports will remember when P. Chidambaram was the finance minister he had hoped the Reserve Bank should adopt an expansionary monetary policy in support of the government’s efforts to push up growth. RBI governor D Subbarao felt otherwise and jacked up the rate. This angered P. Chidambaram and he displayed his displeasure in public by saying that if the RBI and the Govt did not walk together, he would take a solitary walk.
Promptly, Governor Subbarao replied that in his solitary walk, the finance minister would at least sometime feel grateful that the RBI was there. Then, perhaps Subbarao was right.
But now. the Indian economy is slowly reviving after a severe pandemic. Last year, due to lock downs and loss of economic activity, the GDP had shrunk by a quarter in the second quarter of the financial year. Until now wide areas of the economy have been altogether frozen and only recently showing signs of life. An expansionary monetary policy is perhaps the need of the hour. (IPA Service)