Lowering interest rates alone won't pull the economy out of malaise: RBI in ET

The Reserve Bank of India (RBI) has listed a litany of problems the hobbled Manmohan Singh government needs to address to prevent the economy from plumbing new depths, as lower interest rates alone won't pull the economy out of malaise. It held out the example of Singapore to highlight the importance of doing away with cumbersome rules and regulations that hamper businesses in order to keep the economy humming while making a clarion call for businessmen to be honest and settle for a competitive environment where profits are not abnormal. "There is a need to make doing business easy by adopting models like the one in Singapore, where multiple agencies/ministries sit together to quickly give a decision clearing investment projects," Governor Duvvuri Subbarao said in the Reserve Bank of India's annual report for 2011-12. The city-state tops the World Bank's list on ease of doing business while India is ranked 132. "The onus for such clearance clearly rests with the bureaucratic machinery. Businesses also need to rejig their strategies that aim at operating in a more competitive environment earning normal profits within the legal and environmental framework and not try to exploit rules and weak regulation to their advantage at the cost of integrity," the report said. The central bank suggested opening up coal mining for foreign investors and cranking up the bureaucracy, which is slowing down investments and delaying project clearances. Highlights Twin Deficits Subbarao used the annual report to highlight the drag-down effect of the twin deficits — fiscal and trade — on the economy and how uncontrolled government spending would leave lower policy interest rates meaningless. RBI has remained steadfast in holding interest rates despite calls for lowering cost of funds, with the economic growth rate falling to a near-decade low. It had publicly said the government should put its finances in order before expecting monetary easing as lower policy rates would be meaningless if the government crowds out private sector. Inflation control remains the 'cornerstone of monetary policy', it said, adding that recent piecemeal measures by the government may not be enough to revive the stalled economy. RBI's accounting year runs from July to June. Fiscal deficit may overshoot the target for the second year running and current account deficit, the excess of imports over exports, is at a record high of 4.5% of the gross domestic product. "Restraining deficits is important as the budget mathematics still leaves fiscal marksmanship difficult," said the report. "With growth remaining slow, budgetary targets are at risk. With decline in corporate earnings, non-tax revenues from the earnings of public sector units (PSUs) could also fall short of target. It would be hard to meet the divestment target in current market conditions. More importantly, expenditure overshooting arising from under-provision of petroleum subsidies is likely to put the fiscal position under pressure." With Finance Minister P Chidambaram warning that the government may breach the fiscal deficit target of 5.1% of the gross domestic product during the fiscal year and reforms nearly stalled, it may take time for investor sentiment to revive even if the government manages to adopt some reform-friendly policy measures. "Even if we take the right path, it will still take few quarters for the investment sentiment to improve and if we delay taking the right steps, be it cutting subsidies or GST, it is bound to make matters worse," said Samiran Chakraborty, head, India research, Standard Chartered Bank. "Correlation between investment recovery and interest rate action has weakened. Even if RBI cuts rates by 25-50 basis points, it might not be enough to stimulate investments."

��

The government has shelved almost all major economic reforms due to opposition from some of its allies and the main Opposition parties. Legislation is turning difficult, with the Opposition parties stalling Parliament over the alleged scandal in coal block allocation. "The RBI has said there is scope for things to improve if government acts in time," said Upasana Bharadwaj, chief economist, ING Vysya Bank. "But the issue is we have not seen a big breakthrough yet. So it is difficult to perceive a rebound in the macroeconomic situation in the near term." The central bank turned the tables on its critics by saying economic slowdown was due to factors beyond its control and that interest rates may have only contributed marginally. Even if interest rates are lowered, it will not have a positive impact on the economy without sufficient changes in fiscal and other policy actions. "The decline in investments started earlier in H2 of 2010-11 for reasons that were linked to global uncertainties, structural constraints, loss of pro-reform policy momentum, persistent inflation and increasing business uncertainties," it said. "Monetary policy cannot bring about permanent or long-run changes in the levels of output, which are mainly driven by technology, productivity changes and fiscal policy, through its impact on thrift and investment behaviour."