Both bond and stock markets were waiting with bated breath for RBI Governor Shantikanta Das to indicate if inflation was going to be more important or growth on the morning on December 4. While nobody expected policy rates to be reversed, the market was watching every word that could indicate the central bank was turning hawkish – an experience of past pain when earlier RBI governors pulled back just when the economy needed some more continued oxygen of liquidity.
Monetary policy is charged with keeping the flow of the gas of money to the economy at a ‘just right’ reading. Too high a flame will cause irrational exuberance that results in inflation. Too low makes the economy sluggish with growth suffering. Remember, money is the gas that the economy needs to fuel working capital, project finance, retail loans and also government spending and it is the job of the central bank to get this right.
f there is one entity that has earned the respect of a very cynical and hard-to-please group of people – stock and bond dealers, people in the financial sector and economists – it is the Reserve Bank of India (RBI) under the governorship of Shantikata Das. The confident body language, the measured speech and the emphatic statements about doing what it takes to beat the economy back into shape are in stark contrast to a fumbling finance minister – Nirmala Sitharaman – whose body language largely based on unfamiliarity with financial market terms and concepts, does not instill the same sense of comfort and confidence that Das does.
On 22 May, Das, at his favourite time of 10 am, announced another set of measures to deal with the covid crisis. An earlier than scheduled Monetary Policy Committee (MPC) meeting was held to cut repo (the rate at which banks borrow from the RBI) and reverse repo (the rate at which banks lend to the RBI) rates by 40 basis points. This means that banks can both borrow from and lend to the RBI at lower rates of 4% and 3.35%.
Ask any average middle class person what they want from the Budget and the answer is lower prices and less tax. In a way these are contradictory goals because lower tax rates could mean a revenue shortfall. A tax revenue shortfall can cause a government to borrow more, causing the deficit to increase and that could cause a price rise. Didn’t make the link? Let me try and unpack this. The annual budget presentation is a financial statement of the central government where the collection of revenues and its spending is laid out. The government gets most of its revenue from taxes (both direct and indirect) and about one-fifth from non-tax sources. Direct taxes are paid by companies and individuals under various heads (income tax, tax on house property, tax on profits and so on). Of the total revenue, income tax on non corporates (that means us) is about one-fifth of the total revenue for the year. Corporations pay a bit more than we pay. Almost half of the revenue comes from indirect taxes—it used to be excise and sales tax, but now this revenue comes through goods and services tax (GST). The shortfall in revenue over what has to be spent is called a “deficit”. This deficit gets funded largely through the money the government borrows.
If the Union Budget looks ahead at the year and makes forecasts on how the government will gather revenue and spend it, the Economic Survey looks back to take stock of what happened and then lays out the big-picture goals, challenges and scenarios for the Indian economy. It is more of a vision statement than a to-do list. Just as the Budget document has the signature flavour of the finance minister, the Survey carries the DNA print of the chief economic advisor. The key message of Arvind Subramanian’s Economic Survey for 2017-18 can be summed up in one phrase: revival and risk, and he shows this in one chart on the behaviour of bond prices and stock prices. (See table)
The rise and rise of the stock market points to the revival in the economy and the rise in bond yields points to worries on deficit, inflation and oil prices going up. Why are the stock markets rising? The Survey finds that the revival part of the story is “robust and broad based”. With the shock of demonetization and the Goods and Services Tax behind us, gross domestic product (GDP) growth for the current year is estimated to be 6.75% and for the next year between 7 and 7.5 %, making India the fastest growing major economy in the world. The reason for the robustness is the implementation of several deep reform initiatives. GST reform has added another 3.4 million indirect tax payers and GST collections are on an upward trajectory. In fact, the overall trend for widening the tax net is positive. The Survey finds that post-demonetisation, there has been a 0.8% monthly increase in new direct tax filers—an annual growth of 10% or about 1.8 million new taxpayers.
A very irate 70-year-old spoke to me sometime back about his bugbear with the inflation stories he was reading in the papers. The inflation numbers had just been announced and the papers had stories about the rising real return on deposits. The stories celebrated the fall of inflation leading to positive real returns. This means that an inflation number of 4% and a deposit rate of 6% gives a ‘real’ return of 2%, as against an inflation number of 8% and deposit rates of 6% giving a negative real return of 2%. People don’t understand that they are better off, said the stories and comments, they just see the lower nominal return and feel poorer even when they are not. “It’s not as if the price of milk or vegetables has come down,” the septuagenarian grumbled. He’s right. The bite of inflation is such that even when inflation numbers go down, it just means that prices are still rising, but not as fast as before. What the commentators forget is that inflation too has a compounding effect. If compound interest on savings makes our money grow faster, the compounding of inflation makes our money buy less and less. For a retired person sitting on a fixed pot of savings and living off its interest, falling rates of inflation also mean falling deposit rates and that means insufficient funds to live on.
As a kid I remember getting irritated whenever the old people would get together. Now they’ll start talking about how expensive everything is, I used to mutter. Back in those days, kids couldn’t utter aloud all the insidious little comments that were swimming around in their heads when adults were around. “Arrey, on a salary of twenty rupees you could run the house and then have something left over? That shawl mamijee wears, no? That cost a full five rupees. Now toh, you can’t buy it for five thousand only.” Everybody shakes their heads. “Tch tch. Zamana hi kharab hai (these are bad times).” As a kid I remember buying sweets for 5 paise and bus tickets cost 25 paise (and I’m on my way to irritating the life out of kids in the family). My daughter has never seen coins below one rupee. Her daughter will probably say the same for fifty bucks. The fall in purchasing power is the reason that we worry about meeting our expenses when we retire.
A guy I know wanted to retire when he was 25. He just didn’t have the money. If I get Rs1 crore, he said, then I’ll retire. Now, 30 years later, he’s still working and still not done with gathering the corpus he needs to retire. Anyway, he’s wiser and agrees that financial security and going to work need not be either/or. People can continue to work even if they are financially secure. But how much do we really need to save out of our incomes to know that we will hit retirement with enough to maintain our lifestyle for another 30 years? Every time I speak to a friend about buying a life cover, he tells me—the risk we have is not of dying too soon, but of living too long.
This is the new inflation target for the Reserve Bank of India (RBI), with a floor of 2% and a ceiling of 6%. Remember that one of the reasons for inflation, or a rise in the prices, is that governments borrow too much to fund expenses.