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Budget 2003 — Signalling a lower interest rate regime

By C. R. L. Narasimhan

The budget echoes the clamour for soft interest rates, without addressing a few important concerns.

Amidst the general excitement over the tax implications of the budget proposals, one is apt to forget their impact on other constituents of the macro-economic policy, notably the monetary policy. The connection between the fiscal and monetary policies has always been well recognised, especially in recent years. Given the growing linkages within the domestic economy and outside, there is obviously an even greater need to measure the impact of policy pronouncements in one area on another. Needless to add the size of the fiscal deficit, which Jaswant Singh has estimated at 5.6 per cent for 2003-04, influences practically all major economic variables including the inflation expectations and interest rates. Another example: the size of external reserves (at over $75 billion) has implications not just for BOP and trade policy but for even retiring (ahead of schedule) costly external debt (a fiscal matter). For the financial sector and indeed for savings and investment, the impact of the budget on the interest rates will be watched with considerable interest.

The Reserve Bank of India in all its recent bi-annual statements of the monetary and credit policy has consistently opted for a soft interest rate regime. Deregulation of interest rates has been a success in so far as it helped achieve a policy objective. As is well known, practically all benchmark interest rates have been moving down, aided by abundant liquidity. The secondary market in government paper has seen hectic activity and for most banks including the government owned ones a principal means of augmenting incomes.

Just before the budget, however, there was widespread belief that the bottom had been reached. A few major banks had actually started moving up their deposit rates.

The interest rates, that are still administered, the deposit rates of the schemes operated by the National Savings Organisation (the NSO) and the savings bank rates of banks, though significantly lower compared to four years ago were still considered to be high. In the latest budget there has been a reduction in both. In fact the full percentage point cut in the public provident fund and other related rates of the NSO schemes was higher than what many had expected. Working in unison the RBI lowered the SB deposit rates by 0.50 per cent to 3.5 per cent. Geo-political developments rather than pure economic factors alone will determine the direction of the interest rates over the next few weeks and beyond. Of course the budget proposals will be examined more closely for their impact on inflation, which recently has been creeping upwards.

The rationale of a sustainable lower interest rate regime is best understood in the context of the advantages it confers on public debt management. The Government simply wants to lower the cost of its borrowing, not just in a prospective sense but even retrospectively. Banks holding high cost gilts will be persuaded to surrender them, for which money will have to be found. Again, State governments have been offered a swap option that would enable them to reap the benefits of a low interest regime. An estimated saving of Rs. 80,000 crores is expected to accrue but the costs of this exercise including fresh mobilisation (that will have to be made) will fall disproportionately on the Centre. The budget has provided for an 11.8 per cent increase in net Government borrowing. The gross market borrowings of the Centre have been estimated at Rs.166,013 crores and the net market borrowings at Rs.107,194 crores. It is expected that the soft interest regime will prevail at least till a major part of such borrowings is completed. There is enough liquidity in the system that can accommodate even an expected increase in the credit offtake.

An increase in inflation is one major threat to the soft interest regime. Petroleum prices have been volatile on expectations of a war in Iraq. The budget has levied a cess of 50 paise a litre on petrol and diesel, the proceeds to go towards infrastructure. The implications of the extended service tax (it is now at 8 per cent and covers a wider range of services) on the price front will have to be better understood. At present computations of wholesale price indices side step the increase in the cost of services.

The burgeoning fiscal deficit at the Centre and the States is another cause for worry. The losers of a falling interest rate regime are clearly identifiable. Those who have been dependent on fixed income schemes of banks, mutual funds and other avenues including post-office deposits will be worse off than before.

The Finance Minister has however promised a palliative in the form of a new pension scheme from the Life Insurance Corporation of India that will offer a guaranteed 9 per cent yield. However the maximum monthly benefit from this scheme will be Rs. 2,000 only. The Finance Minister has also announced new initiatives in pension reform. However existing pensioners and many others dependent on interest income will not benefit from these.

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