Many challenges to financial stability

The Modi Government is currently engaged in creating more hype on its overall economic management unrelated to ground realities like lurking inflation, low investment, stunted growth, and poor job creation in its first two years, apart from the severely stressed banking system. As the economy enters the second quarter of fiscal 2017 with a growth target of at least 7.5 percent, the outlook, despite a promising monsoon under way, has got more clouded with greater global uncertainties with Britain's move to exit the European Union (Brexit) triggering further tremors across financial markets.

Already, Government is struggling to overcome macroeconomic challenges at home, which are outlined in the Reserve Bank of India's six-monthly Fiscal Stability Report (FSR) in June. No doubt, the Modi Government has acted fast with some policy reforms immediately after RBI Governor Dr. Raghuram Rajan had announced, after "due consultation" with Government, his decision to return to academia when his term ends on September 3. These were apparently to counter the adverse impact on the Prime Minister letting a reputed Central banker leave office at a time of global economic shake-ups.  In what could be this last policy document under his signature, Dr. Raghuram Rajan, Governor, cites fragile global recovery from the crisis of 2008/09, amidst "weak and uneven growth" in both advanced and emerging and other developing economies, the global trade slowdown and continuing uncertainties in financial and commodities markets.

Though India's economy, celebrated at home as the "fastest growing", stands out "in terms of " growth and investment potential", with the Government’s full commitment to continue on the path of fiscal discipline, Dr Rajan said, the efforts on containing the revenue deficit and rationalising subsidies "need to be reinforced”.

While India’s import commodities, especially oil, may go through price reversals adding to sustained food price pressures and rural distress at home, the corporate sector, faced with weaker debt servicing capacity, has yet to begin reviving investment, despite Government’s the measures to ease doing business. The government continues to adhere to faith on a growth upswing to be brought on this year by a favourable monsoon and the big payout in substantial increases in salaries and pensions to lakhs of Central government employees, which should serve as a boost to demand and consumption (equivalent to fiscal stimulus). There is utter dependence on foreign investor response in financing infrastructure and investments in major areas of the economy.

Growth at any cost seems to have become the major concern, taking precedence over inflation. This has indeed affected the FM's relationship with RBI seen as overly concerned with fighting inflation.    But the huge payout has to be matched by revenues if fiscal deficit is to be held at the targeted at 3.5 percent of GDP in fiscal 2017. It looks like the Government would resort to more levies, general and on the railways, to meet the pay bill, an effective squeeze on citizens including some harassment of taxpayers.

The Modi Government was caught off guard by Dr. Raghuram Rajan's announcement on his June 18 of returning to academia when his three-year term ends on September 3. To offset any negative impact abroad and reassure international markets, the Government moved rapidly  to open up the economy for larger and easier access to foreign investors, all with the usual tag of  “providing major impetus for employment and job creation in India”

Dr. Rajan also in his report talked of the need to stay on "the path of sound domestic policies and structural reforms, deal with legacy issues that hold back growth and bring changes to enhance the efficacy of our business processes and conduct". The stress in the banking sector, which mirrors the woes of the corporate sector, has to be dealt with for investments.

On Dr. Rajan himself, for the first time, Prime Minister Modi replying to questions in a special interview on a popular news channel, condemned reckless charges made against the Governor, without taking the name of Dr. Subramanian Swamy and went on to pay compliments to Dr. Rajan whose "patriotism is no less than ours".

There was no reference to monetary policy management which formed part of Dr. Swamy's charge-sheet against Dr. Rajan. All that Modi took care to point out was that they had allowed Dr. Rajan, appointed to the high office by the  previous UPA Government for a three-year term, to complete his term. While the Prime Minister may feel he has dispelled suspicions abroad of political interference leading to Dr. Rajan stepping down, what forced Dr. Rajan to make his decision, despite his known desire to "see through (unfinished) developments" over a period, relating to the banking sector, remains unknown. 

It does not appear that his decision was solely due to the antics of Dr. Swamy, who is known to be closely associated with RSS, and the Prime Minister himself had been a principal “pracharak” of the Sangh. The Modi Government and RSS have a special relationship. But Dr. Rajan does not go simply with the encomium of Mr.Modi.

Finance Minister Arun Jaitley swiftly brought into force the Finance Bill amendment relating to the constitution of a Monetary Policy Committee under the Government-RBI agreement to set the  policy from time to time, in relation to the CPI target set at 4 percent by March 2017, a mechanism which Dr. Rajan himself advocated. The Committee will include three members nominated by Government and three by RBI including the Governor himself with a casting vote.

It is well-known that the Finance Minister and RBI have not seen eye to eye on many occasions of RBI rate fixation, given Government's greater emphasis on growth and Dr. Rajan having staked his reputation as an inflation fighter.  In his three years so far, he helped to stabilise the economy, lower inflation and start building up the reserves in 2013. For last three years, the current account deficit lowered and was easily financed. 

But the Finance Ministry move, in pre-emptive style, forecloses the possibility of Dr. Rajan making his own judgement, no doubt taking into account prevailing global and domestic trends, on the policy stance, when he is scheduled to present the third bi-monthly monetary policy statement on August 9 - that could become the last of his policy reviews.

India's financial stability had never been brought into question in recent years even as Government and RBI tackled the global crisis and double-digit inflation over the period 2008 to 2013. The latest RBI Report says the financial system remains stable but for the banking sector facing significant challenges. As global uncertainties and transiting geopolitical risks impact India, sound domestic policies and structural reforms remain the key for macroeconomic stability, FSR added.