Move over, fiscal policy. Interim Budget 2019 is done, if not dusted. It’s now the turn of monetary policy. But first, what’s the key takeaway from the budget? In cricketing analogy, GoI has bowled a ‘doosra’, a politically clever budget aimed at the elections, but whose implications for macroeconomic stability and debt sustainability are likely to be adverse.
So how will RBI respond when governor Shaktikanta Das presents his maiden monetary policy statement, later this week? Will it step out of the crease and take a chance? Or, given how difficult it is to read a doosra, will it play safe? Under former governor Urjit Patel, the answer would have been a no-brainer. RBI would have put its head down and played by its motto: better safe than sorry.
But we now have a career bureaucrat at the helm. So how will the monetary policy committee (MPC), that begins its three-day meet tomorrow under Das’ chairmanship, read the fine-print of the interim budget?
Remember, fiscal policy is a critical input in deciding the monetary policy stance. When fiscal policy is expansionary, prudence dictates monetary policy should be conservative. More so, when we have a long history of high inflation and RBI has been formally designated an ‘inflationtargeter’.
Sure, the budget presented by interim FM Piyush Goyal is an interim one. Everyone knows the real McCoy is the budget to be presented by the new government in July 2019. But there’s no getting away from the fact that the BJP government has announced a number of ambitious schemes and extravagant giveaways, all of which have a financial cost.
True, over the years, we’ve learnt to take election-eve promises by governments with a pinch of salt. The promise of ‘One Rank, One Pension’ (Orop) for the armed services announced in the UPA’s interim budget of 2014-15, for instance, is yet to be implemented in letter and spirit. These promises have to be financed, eventually. More importantly, they are not easily reversed.
One could argue that these are the compulsions of parliamentary democracy. RBI, however, has no such compulsions. On the contrary. Unlike fiscal policy, monetary policy is expected to be impervious to the compulsions of the great Indian electoral cycle (circus?).
The governor does not need, nor is he expected, to seek the aam aadmi’s endorsement. To quote former RBI governor Raghuram Rajan, he is not in the business of trying to win a popularity contest. He is expected to eschew short-termism — whether of the kind in this interim budget, or Congress’ minimum income guarantee (MIG) promise if voted to power.
He is expected to keep his eye, instead, on the long-term health of the economy. Indeed, to the extent GoI is preoccupied with election shenanigans, this gives RBI elbow room to take decisions without paying heed to subtle — and not-so-subtle — pressures from North Block.
No wonder then that today, all eyes are turned to RBI where the MPC meets to wrestle with the question: does the economy need a leg up? If yes, what sort of crutch should RBI extend? Of the universal basic income (UBI) UBI/MIG kind that maybe good optics, but does very little to resolve the issues before the economy? Or something that puts the economy on a sustainable growth path?
Unfortunately, there are no easy answers. Not only is the fiscal deficit number for 2019-20 of 3.4% well above the 3.1% indicated in last year’s Medium-Term Fiscal Policy Statement, but it’s also built on aggressive (suspect?) revenue assumptions and conservative expenditure estimates.
More importantly, gross market borrowing is up .₹ 2 lakh crore to an unprecedented .₹ 7.71lakh crore. And though net market borrowing is lower at .₹ 4.47 lakh crore, it is gross borrowing that’s a true measure of GoI’s pre-emption of public savings. No wonder the bond market reacted immediately with10-year benchmark government yields rising nine basis points by close of trade on Friday.
The adverse fallout of a borrowings financed fiscal expansion amid deceleration in financial savings on crowding-out and higher borrowing costs for private corporates cannot be underestimated. Already, there is evidence that GoI is cornering a large part of financial savings through off-balance sheet borrowings, pushing up long-term yields, and possibly ‘crowding-out’ private investment. With interest payments estimated to rise 25% in 2019-20 over 2017-18, the signs are ominous.
Agreed, inflation is at a record low (2.19% in December 2018) and is likely to stay low. At the same time, there are indications that growth is slowing, and real interest rates are far too high (at over 4%) to support investment. Reason to meet the doosra with a rate cut?
Possibly. Except that core inflation (excluding food and fuel) is over 5% and there are signs that industry is near capacity-utilization. An increase in demand, especially when the budget has already given a push to consumption, could risk stoking inflation.
In such a scenario, Shaktikanta Das must tread carefully. His first monetary policy statement must steer clear of trying to be a show of strength or of surrender. It must be driven by pragmatism — that is, in these uncertain, and potentially inflationary, times, it may be best to revert to a neutral stance, but sit out the impact of the interim budget before cutting rates.