The CEA has projected that the country will have an energy shortage of 10.3 % and a peak demand shortage of 12.9 %
CHRONIC SHORTAGE:Cooling towers of a super thermal power plant.
The saga of energy shortage will continue for one more year. This is the broad picture that the Central Electricity Authority (CEA)'s annual report on the country's power supply position gives.
In the financial year that just went by, all regions suffered shortage, both in terms of energy and peak demand. The western and northern regions were the worst hit, as they recorded energy shortages of 13.3 per cent and 8 per cent respectivelY.
For the current year, the CEA has projected that the country will have an energy shortage of 10.3 per cent and a peak demand shortage of 12.9 per cent. While the highest energy shortage of 11 per cent will be in the western region, the maximum peak demand deficit, 14.5 per cent, will be felt by the southern region.
According to the CEA, the hydel-rich States having run of river schemes on the Himalayan rivers — Himachal Pradesh, Jammu and Kashmir, and Uttarakhand — will be surplus in energy during south west monsoon (June-September) but they will face severe shortages during the winter low-inflow months when the generation from hydro schemes will dwindle to the minimum. Delhi, Dadra & Nagar Haveli and Sikkim would have both peaking and energy surplus on an annual basis. Though Himachal Pradesh will witness peak demand deficit from November 2011 to March 2012, the State's overall position in meeting the peak demand for the year is expected to be surplus with 7.1 per cent.
In the south, Karnataka and Puducherry will be energy surplus with 4.7 per cent and 4.8 per cent respectively. Other energy-surplus States will be Chhattisgarh, Mizoram and Tripura whereas Orissa will be in a comfortable position in peak demand.
All other States and Union Territories will have electricity shortages of varying degrees both in terms of energy and peak demand. Twenty-five of them will have energy deficit, of which four — Jammu and Kashmir, Uttar Pradesh, Uttarakhand and Daman and Diu — will fall under the category of energy deficit of over 20 per cent; nine under the category of 10-20 per cent and six each in the groups of 5-10 per cent and less than 5 per cent.
Deviations highlighted
One may ponder over the accuracy of the CEA's projections. To be fair to the Authority, the annual report clearly indicates the areas of deviation with regard to the projections for the previous year.
Although the Authority's forecast for the entire country saw only a minor deviation, its projections for some States, particularly those in the South, were well off the mark.
Compared to the anticipated figures, the actual energy availability and peak demand met in the South were higher by 8.9 per cent and 9.4 per cent respectively whereas the actual energy requirement and peak demand were lower by 1.3 per cent and 2.8 per cent. Similarly, the actual energy shortage in the region was 5.2 per cent against the forecast of 14.1 per cent.
The actual energy shortage in Andhra Pradesh was 3.2 per cent (anticipated shortage: 11.6 per cent); Karnataka 7.6 per cent (13.3 per cent); Kerala 1.4 per cent (10.1 per cent); Tamil Nadu 6.5 per cent (18.4 per cent) and Puducherry 4 per cent (5.7 per cent).
The actual peak demand and energy shortage was less than the anticipated due to higher load factor, demand-side management, lower requirement and higher availability of energy.
One more reason was that most of the southern States went on in an aggressive way to purchase power on a temporary and daily basis. As a result, what was sold at Rs. 8 or Rs. 9 per unit in the early part of 2010-11 got almost doubled in the later part of the year. At one stage, the Tamil Nadu Generation and Distribution Corporation bought power daily at an overall cost of Rs. 50 crore. Still, the authorities had resorted to load shedding of 1,500 MW daily.
What policy makers and administrators have to realise is that fundamental and chronic problems cannot be overcome through short-term measures. Additional capacity has to be created in a sustained and rapid manner. There is no short-cut to this option.
During 2010-11, about 12,161 MW only could be added against the target of around 21,440 MW. This year, it has been planned to add nearly 17,200 MW. It appears that the country will not even meet the revised target of about 62,300 MW. When the XII Plan ends, the achievement could be around 50,000 MW. All these only reinforce the need for focussed attention on capacity addition.
T. RAMAKRISHNAN
Close watch on RBI move over recent economic data
Markets are keenly watching how the Reserve Bank of India (RBI) will react to the key economic data that will be released during this week, when it will review the first mid-quarter of this financial year on June 16. The key data are: Wholesale Price Index (WPI) inflation for May to be released on Tuesday, advance tax numbers on Wednesday and monetary policy review meeting on Thursday.
The equity markets ended in the red for the third straight trading session on Friday last, with the NSE Nifty closing below the crucial 5500-mark. The Index of Industrial Production (IIP) growth for April was 6.3 per cent compared to 13.1 per cent in April 2010 as per the new series. Manufacturing growth (year-on-year) stood at 6.9 per cent (14.4 per cent) and mining growth at 2.2 per cent (9.2 per cent).
The base year of IIP has been revised from 1993-94 to 2004-05 by the Ministry of Statistics and Programme Implementation.
The two series have different item baskets and different weightages.
Inflation major concern
Inflation is the major concern for the RBI and in the recent policy announcement, the central bank made clear that even at the cost of a growth rate it had to control inflation and inflationary pressures.
The primary articles group in WPI witnessed a higher inflationary level at 11.52 per cent for the week ended May 28 against 10.87 per cent in the previous week.
Food articles rose to 9.01 per cent from 8.06 per cent.
Meanwhile, Finance Minister Pranab Mukherjee termed the industrial production figures as ‘disturbing', while adding that one should wait for longer term IIP growth to see the underlying trend.
The markets believe that a further interest rate hike (even by a 25 basis points) is imminent, which will have a negative impact on the market sentiment as they will consider the hike as a signal to slowdown in growth.
“The current macro condition of Indian economy is not the most desirable from a growth point of view. The growth is slowing down even as inflation remains well entrenched. This could lead to stagflation,” said Sanjeev Zarbade, Vice-President (Private Client Group Research), Kotak Securities.
Crude oil rose further last week, thus aiding inflationary pressures and at the same time squeezing government finances.
“We believe Indian equities would continue to remain range-bound and may even weaken further given the ongoing euro-debt crisis, fresh worries on U.S. economic growth and domestic economic risks,” he added.
Liquidity system
The liquidity system tightened over the week: average RBI infusion through the repo window was Rs.75,000 crore last week (June 6 to 10), higher than Rs.43,000 crore in the previous week (May 30 to June 3).
In the T-Bill auction held on June 8, the cut-off yield in the 91-day T-Bill auction was marginally higher (8.23 per cent) than the yield (8.19 per cent) in previous week auction (June 1). T
he cut-off yield in the 182-day T-Bill auction also was 8.23 per cent, marginally lower than 8.27 per cent in the auction held on May 25.
It is expected that the RBI will keep the rate hike cycle on and hike the repo rate (and consequently the reverse repo rate as well) by 25 basis points.
However, there is a view emerging in some quarters of the market that the RBI may pause this time, in view of some degree of softening in the global growth rate and the fact that the rate hike was 50 basis points (instead of 25 basis points) on May 3, according to BNP Paribas Wealth Management.
The mild softening in money market yields last week, in spite of tight banking system liquidity, is partially due to this view.
The softening of one-year overnight indexed swap (OIS) reflects the moderation in market expectation on rate hikes going forward.
Taking into account the limited progress on the policy front, Citi India Economist Rohini Malkani said the IIP numbers were likely to remain lacklustre till August.
“We maintain our view that 2011-12 will likely be a year of two halves: with first half GDP in the 7.57-8 per cent (year-on-year) range; and an up-tick in the second half GDP likely to be dependent on a recovery in investments which saw growth decelerating to 0.4 per cent in the fourth quarter of 2010-11.”
The soft fourth quarter GDP data for 2010-11 and other sectoral trends have once again brought debate on a possible pause by the RBI.
Probably, the central bank is in its last quartile of tightening and a further 50-75-basis point hike in policy rates is expected with a likely 25-basis point hike in its policy review meeting on June 16, according to Rohini Malkani.
Given the trend in the overall IIP growth numbers as per the new series and the prevailing inflationary pressures, “we expect the RBI to continue with its rate tightening regime, that is, increasing the repo rate by another 25 basis points in the upcoming monetary policy review,'' said Arun Singh, Senior Economist, D&B India.
Going forward, said Mr. Singh, this would lead to a subdued growth in the consumption and investment demand in the near-term. A slowdown in growth and a rise in food inflation will influence the RBI's plans for a rate hike.
Food inflation
Food inflation is showing signs of inching up adding to the core inflation pressures. Further, another hike in fuel prices is also imminent.
However, the silver lining is that the current expectation on monsoon is closer to 98 per cent normal.
Though the policy tightening since March 2010 would show its impact in the next few quarters, the RBI's focus will remain on controlling inflation while keeping a close watch on growth numbers.
OOMMEN A. NINAN
FHC model: safeguard against systemic failures
The RBI has sought to be the sole regulator of Financial Holding Company
The fall of unfathomable financial institution Lehman Brothers in August 2007 as a prelude to deep financial crisis that gripped the world in the last few years was a wake-up call for central banks. In August 2007, the Reserve Bank of India (RBI) came out with a discussion paper on holding companies in the banking group, where the central bank suggested to have financial holding company or a banking holding company to protect banks against possible adverse effects from the activities of their non-banking financial subsidiaries.
In the meantime, some enthusiastic banking groups, especially the private sector ones, had made their first moves to create ‘intermediate holding companies' by creating layers within their corporate structure, which would have made the central bank's job more difficult in monitoring them. While these discussions were almost concluded without making any headway, the RBI had set up another working group under the chairmanship of Deputy Governor Shyamala Gopinath in June 2010 to examine the feasibility of introducing a Financial Holding Company (FHC) structure.
The issue of the nature of corporate form adopted by financial groups for undertaking various financial activities has acquired relevance from two distinct perspectives — one, efficient corporate management within the groups addressing the growth and capital requirements of different entities, and two, the degree of regulatory comfort with different models, particularly in regard to the concerns relating to contagion risks.
Banks, at present, in India are organised under the Bank-Subsidiary Model (BSM) in which the bank is the parent of all the subsidiaries of the group. The working group was mandated to examine the need and feasibility of introducing a FHC model in the Indian context, including by drawing lessons from the global financial crisis.
The formation of FHCs should be seen in the background of the global financial crisis. The RBI says: “The recent global financial crisis can be said to be model agnostic as far as the form of conglomeration is concerned. ....... The post crisis reform proposals do not specify preference for any particular model. The focus, as far as structure is concerned, is on strengthening capital requirements at the consolidated level; reducing complexity of structures to enable efficient resolution of financial institutions; and separation of investment banking from commercial banking”.
From a regulatory perspective, one of the key risks posed by the BSM is that the parent bank is directly exposed to the functioning of various subsidiaries and any losses incurred by the subsidiaries inevitably impact the bank balance sheet. It therefore becomes imperative that the bank regulator has an interest in the health of all subsidiaries under the banks, even as each subsidiary is under the jurisdiction of the respective sectoral regulators.
The most obvious risk from affiliation of banks with non-banks is the risk of transference to non-bank affiliates of a subsidy implicit for banks in the safety net, deposit insurance, access to central bank liquidity and access to payment systems, with the attendant moral hazard. This subsidy is more readily transferred to a subsidiary of a bank and can, to a certain extent be reduced through the holding company structure. The other risk posed by this model is the difficulty in resolution if the bank, or any of its subsidiaries, is in trouble.
The working group felt that a holding company structure may enable a better supervision of financial groups from a systemic perspective. It would also be in consonance with the emerging post-crisis consensus of having an identified systemic regulator responsible inter alia for oversight of systemically important financial institutions (SIFIs). “A holding company model would provide the requisite differentiation in regulatory approach for the holding company vis-à-vis the individual entities.”
Suitable model?
On balance, a holding company model may be more suited in the Indian context. It, however, was conscious of the fact that regardless of the organisational forms, banks cannot be totally insulated from the risks of non-banking activities undertaken by their affiliates. It also recognised that there are divergent ownership and governance norms for various sectors and also entities within the sectors. The divergences primarily reflect regulatory and public policy objectives. There are also legacy issues concerning the existing conglomerates. “Any framework to harmonise them at the level of the FHC would be a challenge and therefore the FHC as a preferred model will need to be phased in gradually”.
While emphasising the view that the FHC model should be a preferred model for all financial groups, irrespective of whether they contain a bank or not, the working group said the ‘intermediate holding companies' within the FHC should not be permitted “due to their contribution to the opacity and complexity in the organisational structure”.
In the post-crisis analysis, the financial groups without banks could also be of systemic importance particularly if they are large and undertake maturity and liquidity transformation. This would be particularly relevant in the case of large conglomerates coming under the existing financial conglomerate supervision framework. So it was recommended that there can be Banking FHCs controlling a bank and Non-banking FHCs which do not contain a bank in the group.
Paving the way for a holding company structure for financial entities, the RBI has introduced two important caveats — the apex bank has sought to be the sole regulator of FHCs, irrespective of a bank's presence in the holding company or not and it has also sought a separate regulatory framework with a new Act.
The working group considered various possible options in this regard and concluded that a separate regulatory framework for FHCs, overarching the existing functional regulation for various segments, would be the most desirable alternative.
Firewall provisions
While firewall provisions can be important safeguards in preventing potential conflicts of interest and protecting insured deposits, in reality, the firewalls may not hold up, the working group felt.
Such a framework would also ensure that there is no ‘product arbitrage' across different functional regulatory regimes. However, the working group was very clear that the role of the financial holding company regulator would be supplementary to the role of existing functional regulators.
As regards the legal framework for separate regulation of FHCs, it has recommended that the enactment of a separate Act for regulation would be the most efficient alternative. It will avoid any legal uncertainties that could be there if FHCs were to be governed by amending the RBI Act or Banking Regulation Act. It will align the regulation of FHCs with the objectives of systemic oversight and it will enable design of a regulatory framework for FHCs different in scope and focus from entity regulation.
Further, the RBI has recommended that the amendments should also be simultaneously made to other statutes/Acts governing public sector banks, Companies Act and others, wherever necessary. Alternatively, in order to avoid separate legislation for amending all individual Acts, the provisions of the new Act for FHCs should have the effect of amending all the relevant provisions of individual Acts and have over-riding powers over other Acts in case of any conflict.
While strengthening the sense of responsibility in ownership, the RBI's efforts are in the right direction to avoid a systemic failure in the financial system in future, thus protecting the interest of all stakeholders.
OOMMEN A. NINAN
SAIL game plan to become a global player
SAIL Chairman Chandra Shekhar Verma (centre) viewing the modernisation plan model for the Durgapur Steel Plant.
Steel Authority of India Ltd. (SAIL) hopes to emerge as a global company in the next few years, Chairman Chandra Shekhar Verma said. Even as the company races to complete its Rs.72,000-crore modernisation plan, it has put in place a perspective plan to increase the capacity to 60 million tonnes by 2020 from the present 14 million tonnes. “Our target is to take the company from being a domestic player to a global brand,'' Mr. Verma told this correspondent.
Global ambitions
Mr. Verma said the stakeholders of the company would see the emergence of a global SAIL in the months to come. To realise this game plan, the company was working on multiple fronts at the international level by adopting the inorganic route and going in for strategic tie-ups aimed at backward, forward and lateral integration. The strategy hinged on ensuring domestic and overseas raw material security through the acquisition route while marking a footprint overseas through greenfield units in mineral-rich countries. On the scanner are countries like Mongolia and Indonesia for units and Australia for acquisition of properties. At least one deal for coking coal was likely within this fiscal, he said.
In times where securing raw material supplies are central to existence, tie-ups with rival domestic companies are no longer a taboo and Mr. Verma said discussions had been held with Tata Steel, JSW, JSPL, RINL and Bhushan Steel and others for the Hajigak mines in Afghanistan where SAIL had already bid.
SAIL secures iron ore from its captive sources and the recent environmental clearance given by the government for mining in the Chiria mines in Jharkhand had also strengthened its position, Mr. Verma said. In Chiria, SAIL had sought forestry clearance for about 25 per cent (595 hectares) of the total leasehold area to start mining operations, for which stage-I forestry clearance had been provided. Environment clearance for Budhaburu, the biggest lease of Chiria (824 hectares), had also been granted.
Development activities for setting up a 14 million tonnes per annum (run-of mine) mechanised mine were under progress at Rowghat to meet the Bhilai Steel Plant's long-term iron ore requirement. Only 30 per cent of the coking coal requirement was met from indigenous sources he said. To reduce dependence on increasingly costlier imported coal, SAIL had laid a thrust on developing the coal-blocks allocated to it by the government besides expanding production from captive collieries.
The ongoing phase of modernisation to increase the capacity from 13.82 million tonnes to 23.50 million tonnes with an investment of about Rs. 72,000-crore, including modernisation and expansion of iron ore mining capacity, would be completed by 2012-13. A milestone-based monitoring system was being put into place, Mr. Verma said. Referring to the 2020 plan, Mr. Verma said that dovetailing with the government's plans to increase the domestic steel production capacity to 180 million tonnes by 2020, SAIL too was putting a perspective plan in place to raise the production capacity to 60 million tonnes by 2020.
“Our target is to take the company from being a domestic player to a global brand. SAIL also plans to increase its share in the domestic market from the present 19-20 per cent to one-third of the market for steel.''
On SAIL's strategy for staying ahead at a time when its competitors too are racing ahead with their expansion plans, Mr. Verma said the company's people-focus had led to highest-ever labour productivity of 241 tonnes a man. SAIL also planned to increase the share of value-added products in its product basket, from the present 38 per cent to around 50 per cent.
Mr. Verma said SAIL had tied up with top steelmakers such as Nippon Steel, POSCO and Kobe Steel for joint ventures. SAIL was working with Kobe Steel of Japan to install a 1.5 million tonnes steel plant based on gas-based DRI technology and using electric arc furnace for steel-making with value-added products at Jagdishpur in Uttar Pradesh. The feasibility of setting up a 1,000-MW gas-based power plant was also being examined.
“SAIL is in talks with different governments like Mongolia and Indonesia for setting up steel projects. We are aggressively pursuing equity participation with existing leading coal mining companies. Due diligence of some coal assets is in progress and we hope to finalise these shortly. At present, I would not like to comment on any proposed tie-up with Arcelor.''
INDRANI DUTTA
Occasional sparks rekindle hopes of Indian steel firms
The steel industry, which suffered a blow during market meltdown is recovering steadily with occasional sparks rekindling the hope of steel-makers.
Steel production and consumption are one of the major indices of economic growth and development but production and consumption depends on the extent to which market supports such drive. Before meltdown, the steel market was upbeat for long during 2003-08, a good luck period for a steel-maker. The period was marked by a quantum jump in output of crude steel across the world from 970 million tonnes in 2003 to 1,329 million tonnes in 2008 accounting for 37 per cent increase.
Global steel market
Taking advantage of the feel-good factor in the steel sector, many new companies mushroomed with steel making facilities in greenfield as well as brownfield expansion. It suffered a jolt due to the turmoil in the global economy and since then the steel market is witnessing a sluggish growth. Worldwide steel production and consumption started the upward swing from 2009.
During 2010, global steel market remained sluggish due to higher growth of around 15 per cent in production of crude steel, de-stocking and buyers adopting ‘wait and watch' approach. In the current year, crude steel production is likely to grow by 5 per cent as against 15 per cent in the previous year.
This rate may also get affected due to slackening of appetite for growth in China and Japanese mills suffering on account of tsunami and its after-effect.
In the international steel market, it will not be a question of excess availability of finished steel, as in last year rather it will be an issue of consumption.
Given the forecast of rate of consumption being around 5 per cent, international market, except for seasonal drop, will look up during this year. On the world market, Chairman-cum-Managing Director of Rashtriya Ispat Nigam Limited (RINL) P. K. Bishnoi, when contacted said: “China, India, Brazil and South Korea will continue to drive global growth in steel. With Western countries registering positive consumption and growth, the steel market is bound to come out of sluggishness”.
Good sign
The good sign is that the domestic market during 2010-11 was quite subdued but the domestic prices of steel have been ruling more than the international prices.
During the last fiscal, steel market in India started moving up only from December 2010.
An interesting feature from the behaviour of steel market was the response to international scrap price instead of coking coal. Coking coal price on an average rose by $89 a tonne in 2010-11. There was no upward movement in the market but when scrap prices in December 2010 rose by $50 from $425 to $475 a tonne, steel prices started moving up and it stopped rising once scrap prices dropped to $427 a tonne in mid-February 2011.
T. K. Chand, Director (Commercial), RINL, points out that 74 per cent of production in long products remained with thousands of secondary producers. He also said that yearly steel cycle generally started moving up from the middle of third quarter of the year. However, in 2010-11, it started moving up only from December 2010, mainly due to sluggishness in the international steel market.
On the prospects of domestic steel market this year, he predicted that it is bound to look-up given the gross domestic product (GDP) growth projection of 9-9.5 per cent and industry, infrastructure, housing, construction, power and automobile sectors registering reasonable growth rates. However, he said that the margins of steel producers might be greatly eroded due to steep increase in the prices of key raw materials such as coking coal by around $105 a tonne and iron ore by around $30-40 a tonne, which might affect the growth of the steel sector, unless suppliers take a reasonable approach.
In this see-saw game of steel market, it is quite rewarding to review the growth of RINL, one of the main producers located in Visakhapatnam, Andhra Pradesh, which was once upon a time reported to the Board for Industrial and Financial Reconstruction (BIFR), but bounced back to become first a miniratna and now a navratna company. It is also encouraging to note that the company has no key captive raw materials like iron ore and coking coal, yet the company is progressing by its sheer efficiency in value addition.
In the last fiscal, the company has recorded a higher sales turnover of Rs.11,517 crore, a jump of more than Rs.1,000 crore over that of the previous year. Again in 2011-12, RINL is faced with a gigantic task of achieving a target of over Rs.13,600 crore of sales turnover.
Director (Projects) A. P. Choudhary is quite optimistic about completing the expansion scheme in time.
Mr. Choudhary also indicated that secondary refining facilities in steel-making like ladle furnace, electro-magnetic stirrer and RH de-gasser are being set up, which facilitate production of cleaner steel of high-end value addition, suitable for applications such as axles, seamless tubes and automobile components.
On strategies to meet the market challenge, the RINL CMD said that RINL was focussing now on a dynamic market mix with more emphasis on customisation of products and services. He points to the recently concluded ‘Partners' Summit-2011” in taking the customer on-board.
SANTOSH PATNAIK
Wake-up call to the Centre from RBI
Time-bound action needed and not mere promises and studies
The latest review of interest rates of banks announced by the Reserve Bank of India on May 3 included an increase in short-term lending rate by 50 basis points to 7.5 per cent and short-term borrowing rate by 50 basis points to 6.25 per cent. The RBI Governor, D. Subbarao, has justified this as necessary to moderate inflation even if it means a slowing down of growth in the short run. The gross domestic product (GDP) expectation for 2011-12 has been lowered to 8 per cent. The RBI Governor has warned that high and persistent inflation undermines growth by creating uncertainty for investors and driving up inflation expectations. He has called for an increase in prices of petrol and diesel.
Main trigger
It seems the initial reaction was to treat inflation as a supply bottleneck problem. Later, spurt in demand was considered as the main trigger. Over the last 12 months, the RBI has increased bank rates eight times but the latest one is the steepest. The perception is that these are too late and too little. It is, however, necessary to understand the predicament of the RBI. Monetary policy and tools are not the sole devices to promote economic growth. Fiscal policy is a vital ingredient. These should work in tandem. Any disconnect will lead to unacceptable economic slowdown. The persistent fiscal deficits in government budgets lead to government borrowings which increase the money supply and liquidity in the economy. This is what has been happening in India. The increasing fiscal deficits of the Central and State governments over the last few years have placed the RBI in a difficult position to control liquidity and moderate inflation.
The fiscal problems and issues to be tackled by the government go beyond budgetary deficits. How the revenues are raised and how the public money is spent raise the important role of good governance especially in implementation. Investor confidence in the future is not a quantifiable concept but will be encouraged only by visible proof of good governance. For an immediate and ready example corruption is a virus which is eating into the vitals of the economic system. It pervades the whole gamut of raising and spending public money.
The proposal to set up an apex body to deal with this canker has been in limbo for the last so many years and has been revived only now with the Lok Pal bill and that too by public outcry and protest: the bill is only in the drafting stage and the start has been mired by unnecessary controversy. Black money is a huge drain on the country's wealth and revenues. The action taken so far has not made any dent. The Supreme Court has expressed its displeasure with the non-action in tracking black money. The only response it has got from the government is the proposal to set up a committee to study the problem revealed by the Finance Minister when he presented the central budget in February this year.
The control of fiscal deficit also presents a poor track record. The Fiscal Responsibility and Budget Management (FRBM) Act 2003 has not helped in tackling the root of the problem. There has been obsession with showing compliance with quantitative deficit targets .This has been based on revenue buoyancy and one-time receipts like spectrum auctions. The resulting complacency has sidetracked major fiscal issues and problems. The so called medium-term road map for achieving fiscal consolidation is not based on any time-bound action to identify and reform these problems. The list is substantial covering revenue and expenditure.
These have been covered in detail in these columns in the past. Broadly the problems are fundamental review of government functions, activities and schemes, addressing the policy and implementation issues to reduce subsidies, prioritisation of expenditure, dependency of public sector enterprises on government budget, sick and loss making enterprises due for closure, transparency in budget and accounts, accountability, use of output and outcome budget as a management tool and critical examination of tax revenue forgone which was nearly Rs.5-lakh crore in 2009-10.
Even the computation of fiscal deficit ignores quasi fiscal deficits like those of Central Public Sector Enterprises and Special Purpose Vehicles (SPV). These are relevant in addressing the overall liquidity position which the RBI has to tackle through monetary measures.
Another crucial point in deficit control is the State government deficits and the borrowings which again affect the liquidity in the economy. The Central Government can make the States follow the fiscal path through leveraging funds transferred to them annually as central assistance. But they can do this only if they set their house in order and adopt a reform-based medium-term road map.
Supply-side problem
The current inflation in food prices deserves a special mention. This seems to be a supply-side problem. The aspects needing consideration and action are modern methods in farming, supply of improved seeds, useful extension service, proper storage for grains, rural loans and improved irrigation and water supply to reduce dependence on rain fed crops. Output and outcome budgeting can be useful in ensuring proper use of irrigation dams and reservoirs to improve efficiency in water use and evolving suitable crop pattern. As a medium-term agenda the Central Government can take action to amend the constitution to make agriculture, water and irrigation a concurrent subject instead of a purely state subject. Interlinking of rivers and canals can also be a long-term project.
In conclusion, what is needed is urgent and time-bound action plan to reform all these issues and not mere promises and studies. For better coordination of fiscal and monetary policies a parliamentary committee can call the Finance Secretary and the Governor of RBI for a joint hearing.
A. RANGACHARI
Big push to deregulation of savings rate
In most countries, interest rates on savings bank accounts are set by commercial banks based on market conditions
A HAPPY LOT: Bank customers have something to rejoice as the Reserve Bank of India raised the savings bank account interest rate by 50 basis points to 4 per cent in its annual policy for 2011-12. The picture shows a busy day at a nationalised bank branch in Chennai.
Freeing savings bank rate is a complex issue in India. The Reserve Bank of India (RBI) recently launched a debate on this issue by presenting a discussion paper prior to its Annual Monetary Policy for 2011-12.
While announcing the policy, the RBI has also raised the savings bank rate from 3.5 per cent fixed in 2003 to 4 per cent. The spread between savings deposit and term deposit rates has widened significantly in recent times. This was why the RBI raised the savings bank rate, while a decision on freeing these rates was pending before the central bank for a final decision.
“We want to be sure that it contributes to financial inclusion. So that it does not militate against financial inclusion,” said the RBI Governor, D. Subbarao, in his post-policy press conference, referring to the deregulation of savings bank rate.
On raising the savings rate his deputy Subir Gokarn said that this rate had been at 3.5 per cent since 2003 all other rates have been deregulated, rates have moved up and down in the last eight years but this one had not and so as part of the overall adjustment, deregulation was still a debated proposition whether “we should let it go or not”. But given the differential that had emerged between this rate and all the other rates, particularly in this upward cycle, the RBI thought that an adjustment was necessary.
With regard to all other interest rates, Dr. Subbarao has pointed out that “We moved away from regulation”. Almost all interest rates, except the one on savings bank and NRI deposits which are administered as of now, are deregulated. So, “we believe that that is the way to move forward but again I want to say that we are open-minded and we would certainly respect and are being open to all the feedback that we get”.
Now banks have complete freedom in fixing their domestic deposit rates, except interest rate on savings deposits, which continues to be regulated. In pursuance of the announcement made in the Annual Policy Statement for 2009-10, the Reserve Bank advised scheduled commercial banks to pay interest on savings bank accounts on a daily product basis with effect from April 1, 2010.
Prior to the introduction of a daily product method, interest on savings deposit account was calculated based on the minimum balance maintained in the account between the 10th day and the last day of each calendar month and credited to the depositor's account only when the interest due was at least Re.1 or more. After this change, the effective interest rate on savings bank deposits increased, benefiting the depositors.
Savings accounts are maintained for both transaction and savings purposes mostly by individuals and households. A savings account, being a hybrid product, provides the convenience of easy withdrawals, writing/collection of cheques and other payment facilities as well as an avenue for parking short-term funds which earn interest. The maintenance of savings bank deposit accounts, however, entails transaction costs. In fact, a term deposit doesn't involve transaction cost for banks.
Savings deposits are an important component of bank deposits. The average annual growth of savings deposits, which decelerated in the 1990s compared with that of the 1980s, accelerated sharply in the decade of the 2000s. In this decade, the average growth rate of savings deposits exceeded that of demand and term deposits, notwithstanding the growth in term deposits outpacing that of savings deposits during 2005-10. The RBI had raised several questions on this issue. Should savings deposit interest rate be deregulated at this point of time? Should savings deposit interest rate be deregulated completely or in a phased manner, subject to a minimum floor for some time? How can the concerns with regard to savers (senior citizens, pensioners, small savers, particularly in rural and semi-urban areas) be addressed in case savings deposit interest rate is deregulated? How serious are concerns relating to a possible intense competition among banks and asset-liability mismatches if savings deposit interest rate is deregulated? Should higher interest rate be paid on savings deposits without a cheque book facility?
Global experience
In sum, deregulation of savings deposit interest rates has both pros and cons. The RBI's view, as reflected in the discussion paper, was that savings deposit interest rate could not be regulated for all times to come when all other interest rates have already been deregulated as it created distortions in the system. International experience suggests, according to the RBI, that in most countries, interest rates on savings bank accounts are set by the commercial banks based on market interest rates.
Most countries in Asia experimented with interest rate deregulation to support overall development and growth policies. These resulted in positive real interest rates, which in turn contributed to an increase in financial savings.
Further the RBI argues that deregulation of savings bank deposit interest rate also led to product innovations.
The flowery points of the RBI are likely to give a push for a de-regulation. However, unlike many other countries in Asia as well as other parts of the world, the Indian situation is different. A large number of people in India are from the rural background with less saving.
The urban poor, migrated from the remote rural areas of the country too are having small savings.
The urban labourers send their weekly earnings through public sector banks (PSBs) to their dependants living in villages.
Further, with larger presence in rural and semi-urban areas, the PSBs would be having maximum number of small savings bank account holders. Generally, the PSBs were attracting small customers along with other high value depositors, who trust PSBs compared to other private sector banks.
Maintaining an account with huge balance in savings bank would be cheaper for banks than maintaining an account with small balances as transaction cost of banks would be higher in the case of small account holders. In the case of salaried employees, their salaries would be credited to a particular bank. As the regulator frees the savings bank rate, the private sector and foreign banks will offer boutique products and fascinating interest rates to attract these huge accounts from corporates as well as government organisations.
Deregulation of savings bank rate would work against financial inclusion as public sector banks saddle with all un-remunerative accounts and all high value accounts would migrate to the new generation private sector banks and the foreign banks. Always the small customer is at the receiving end.
OOMMEN A. NINAN
How the process started
The process of deregulation of interest rates was resumed in April 1992 when the existing maturity-wise prescriptions were replaced by a single ceiling rate of 13 per cent for all deposits above 46 days.
The ceiling rate was brought down to 10 per cent in November 1994, but was raised to 12 per cent in April 1995. Banks were allowed to fix the interest rates on deposits with maturity of over two years in October 1995, which was further relaxed to maturity of over one year in July 1996.
The ceiling rate for deposits of 30 days and up to one year was linked to the Bank Rate less 200 basis points in April 1997.
In October 1997, deposit rates were fully deregulated by removing the linkage to the Bank Rate. Consequently, the Reserve Bank gave the freedom to commercial banks to fix their own interest rates on domestic term deposits of various maturities with the prior approval of their respective board of directors/asset liability management committee (ALCO).
Banks were permitted to determine their own penal interest rates for premature withdrawal of domestic term deposits and the restriction on banks that they must offer the same rate on deposits of the same maturity irrespective of the size of deposits was removed in respect of deposits of Rs.15 lakh and above in April 1998.
A departure from conventional approach
The objective of the Reserve Bank of India will be to condition an environment to bring inflation down to 4-4.5 per cent
CALIBRATED MOVE:RBI Governor D. Subbarao (second from right) with Deputy Governors before announcing the monetary policy in Mumbai recently.
The Annual Policy 2011-12 was substantially different from all other recent monetary policies announced by the Reserve Bank of India (RBI). While it stressed more on the current as well as future inflationary pressures and the ways and means to mitigate its horrors, the RBI decided to sacrifice the prevailing growth rate and cut that to 8 per cent for 2011-12 from the last year's 8.6 per cent.
A subdued RBI Governor D. Subbarao was at pains to explain how inflation would affect growth. He has also admitted that RBI failed to judge or foresee the inflationary pressures early, which even affected the credibility of the RBI.
Even though the trend of moderating inflation and consolidating growth in the second and third quarters of 2010-11 justified the calibrated policy approach of the central bank, the resurgence of inflation in the last quarter of 2010-11 was a matter of concern.
Economic stability
By dropping its earlier calibrated approaches, the RBI has entered a mission in this financial year to focus on economic stability by anchoring inflation expectation instead of sustaining growth momentum. It hiked the repo rate by 50 basis points from 6.75 per cent to 7.25 per cent, tightened some provisioning norms and there is also a 50 basis point increase in the interest rate on savings deposits from 3.5 per cent to 4 per cent.
While the RBI expects inflation to be close to 9 per cent in the first-half of the current fiscal that began in April, it has projected the headline number to moderate to 6 per cent by end-March 2012.
At present, inflation is hovering between 8 per cent and 9 per cent or close to 9 per cent, a high level as compared to RBI's target levels. The objective or the endeavour of RBI will be to condition an environment to bring inflation down to 4-4.5 per cent and to bring an environment in the medium term of 3 per cent inflation consistent with the global inflation scenario. Meanwhile, Chief Economic Advisor Kaushik Basu is hopeful that April headline inflation is expected to ease to 8.3 per cent. The number rose to 8.98 per cent in March from 8.31 per cent in the previous month.
RBI fixes grace period
Now the RBI has fixed a grace period for the rising prices to take a reverse trend, by “the first-half of the current year”. However the situation is very bearish and negative as global commodity prices are moving up and demand also is rising. Complexity in economic situation would reach its nadir once inflation remains near 9 per cent or above 8 per cent and growth momentum falls below 8 per cent as at end September 2011. The central bank's expectation of a growth momentum was based on the assumptions of a normal monsoon and global crude oil price of $110 a barrel. Once the present socio-political scenario in the Middle East and North African nations worsens, commodity prices would escalate further.
This annual policy has also surprised the markets. When the RBI signalled the market by raising the repo rate — the rate at which banks borrow funds from the central bank — by 50 basis points — the equity market dipped by 463.33 points or 2.44 per cent to 18534.69 with banking, real estate and automobile counters leading the decline on May 3. For the week ended May 6, it closed at 18518.81 compared to the previous week's close of 19135.96, a loss of 617.15 points. The market was expecting a rise of 25 basis points. However, the markets belatedly accepted the fact that the RBI's move clearly reflected its concern about rising prices. Hereafter RBI will have only one single policy rate, the repo rate, to indicate the rate changes in the banking system.
The significant changes announced by the RBI in its operating procedure of monetary policy are expected to bring in more clarity in the policy rates. Further, this would enhance the transmission of monetary policy and reduce volatility in overnight call money rates. The reverse repo rate (the rate at which banks park their funds with the central bank) will continue to be operative, but it will be pegged at a fixed 100 basis points below the repo rate. Hence, the reverse repo rate will no longer be an independent variable.
Further, the RBI has instituted a new Marginal Standing Facility (MSF). Banks can borrow overnight from the MSF up to one per cent of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be 100 basis points above the repo rate. As per the newly introduced scheme, the revised corridor will have a fixed width of 200 basis points. The repo rate will be in the middle. The reverse repo rate will be 100 basis points below it and the MSF rate 100 basis points above it.
The RBI has demonstrated, as an aggressive central bank, with nine rate rises since March 2010, post-global financial crisis. But gradual policy tightening (a “baby step” of 25 basis points each) failed to quench the fuelling price rise.
With the “long step” of a rise by 50 basis points, tough conditions would prevail in the economy. Rising commodity prices, increased fuel subsidy, subsequent risk of overshoot in government borrowing and pressure on trade gap are factors which would make the central bank's task more difficult.
Three factors that shaped the monetary policy
Three factors have shaped the outlook and monetary policy for 2011-12. First, global commodity prices, which have surged in recent months are, at best, likely to remain firm and may well increase further over the course of the year. This suggests that higher inflation will persist and may indeed get worse.
Second, headline and core inflation have significantly overshot even the most pessimistic projections over the past few months. This raises concerns about inflation expectations becoming unhinged.
The third factor, one countering the above forces, is the likely moderation in demand, which should help reduce pricing power and the extent of pass-through of commodity prices. This contra trend cannot be ignored in the policy calculation. However, a significant factor influencing aggregate demand during the year will be the “fiscal situation”.
The budget estimates offered reassurance of a fiscal rollback. However, the critical assumption that petroleum and fertilizer subsidies would be capped, is bound to be seriously tested at prevailing crude oil prices. Even though an adjustment of domestic retail prices may add to the inflation rate in the short run, the Reserve Bank believes that this needs to be done “as soon as possible”. Otherwise, the fiscal deficit will widen and will counter the moderating trend in aggregate demand.
The latter portion of the third factor is the operative and crucial part which shapes the monetary policy outlook for the current fiscal. The RBI is in a hurry to pass-through the high oil prices to consumers. Otherwise, navigating inflation to a soft landing of 6 per cent at end March 2012 would end up as an unfinished agenda for the central bank.
The monetary policy trajectory that is being initiated in this annual statement is based on the basic premise that over the long run, high inflation is inimical to sustained growth as it harms investment by creating uncertainty. Current elevated rates of inflation pose significant risks to future growth. Bringing them down, therefore, even at the cost of some growth in the short-run, “should take precedence”.
OOMMEN A. NINAN
Regressive impact of world inflation
The situation in India is comparatively less uncomfortable than in other countries
The calibrated monetary policy aimed at taming inflation and at the same time sustaining the growth process has been given up. The Reserve Bank of India Governor D. Subbarao is anxious that persisting high inflationary levels should be effectively tackled, even with the growth process getting slowed down, for avoiding the emergence of new pressures.
Towards this end, the repo and reverse repo rates have been raised by 50 basis points for the first time in recent months. Different procedures are, of course, being adopted for reckoning variations in key interest rates though the actual cost of credit will be one percentage point higher than the repo rate.
Though it is generally agreed that the monetary authorities have adopted a conservative approach and inflationary pressures have to be effectively checked even if the earlier calculations about the pronounced growth in gross domestic product GDP will get reduced to 8 per cent, many questions remain unanswered.
In some quarters it is felt that food inflationary pressures are getting under control and new difficulties have risen only on account of imported inflation.
Having regard to the assertion of inflationary pressures, the world over it can be safely claimed that the situation in India is comparatively less uncomfortable than the conditions in other countries.
Foreign trade
The trends in foreign trade in 2010-11 clearly indicate that agro as well as manufactured products are competitive in the traditional markets in the West as well as new areas in Latin America and elsewhere.
This will be borne out by the fact that the uptrend in exports in the past year has been sustained and shipments of textiles, leather, gems and jewellery, engineering goods and other items have fetched handsome foreign exchange earnings.
Also, there is no suggestion that the demand for various goods and services will be less keen. Indeed, having regard to the development in world markets, the uptrend in exports will be sustained and the plans for achieving growth in exports in excess of 25 per cent will be easily feasible. It will not then be difficult to secure forex earnings of $500 billion yearly in three years.
The favourable developments in 2010-11 facilitated a growth in export earnings of 67.12 billion while imports have risen by $62.32 billion despite an increase in the oil import bill.
The trade deficit could, therefore, be contracted by $4.80 billion to $ 104.83 billion. The favourable trends in exports and a pick-up in net invisible receipts, the current account deficit for October-December could be reduced to $9.7 billion ($12.2 billion). There will, of course, be an increase in this deficit for the whole year because of the unfavourable experience in April-September on account of a slow down in net invisible receipts.
The balance of payment position has remained comfortable as the bigger current account deficit could be easily absorbed as the net foreign exchange assets have increased to $273.70 billion (at the end of March 2011) from $252.76 billion (at the end of March 2010).
Agro sector
Another favourable factor for the economy as well as consumers is the extremely commendable performance of the agricultural sector in the 2010-11 agricultural season ending in June.
The latest estimates indicate that an all-time record has been established with the output of foodgrains rising to $235.88 million tonnes from the earlier peak of 234.47 million tonnes (2008-09). Even with a lower yield of rice, procurement purchases have been encouraging in the current marketing season so far. Also, it is hoped that wheat procurement will surpass the 25 million tonne mark (April-March). Taking into account the estimated current account deficit of $46 billion for the whole of 2010-11 and the outflows for investment purposes, the gross addition to forex assets were $68 billion.
As the meteorological experts expect that the monsoon will behave satisfactorily in the forthcoming kharif season, the Ministry of Agriculture has estimated that the output of food crops may be even 250 million tonnes. If these expectations materialise, it will be well nigh impossible to store bulging food stocks in good condition.
If exports have to be effected in limited quantities even after meeting the requirements of those below the poverty line on the stipulated basis, higher export prices for fine cereals may push up prices for both these cereals in the domestic market which will get reflected in a higher food inflation index. Fears in this regard have perhaps been responsible for continuing the ban on exports. Even otherwise the food index has been fluctuating irregularly around 8.5 per cent and if there has been no noticeable drop from this index in this level it is due to higher prices of other products which are not available in the desired volume or which are becoming costlier due to adjustments in procurement prices.
In fact, in respect of wheat the minimum support price (MSP) for the current season has been raised and some State governments also have agreed to raise the procurement price by Rs.100 a quintal.
A further drop in food index depends on the developments in the coming months with supply constraints in some directions getting moderated and availability from indigenous sources turns out comfortable.
Against this background, it is imperative that there should not be any disincentive for creating additional capacity wherever necessary and maximising production with the existing facilities. In fact, the earlier calculations regarding a pronounced growth in GDP by 9 per cent were based on the scope for raising the yield of food and cash crops to new high levels and a satisfactory growth in industrial output.
Though the trends in industrial production in 2010-11 have given rise to misgivings about sustained increase in industrial output, there is reason to believe that the details relating to variations in industrial output have not taken into account adequately the commendable performance of the textile, leather, consumer durables, gems and jewellery, engineering goods and other segments of the industrial sector.
If industrial growth slackens on account of paucity of resources for implementing on-going and new schemes, there will be a distorting effect.
The fears of the monetary authorities in regard to rise in inflation rate in the coming months on account of upward adjustments in prices of petro-products and the impact of external factors there will surely be a heightening of inflationary pressures in the short-term as visualised by the monetary authorities. (Luckily, there has been a short break in crude prices by more than $10 a barrel due to favourable developments in the Middle East and on the terror front.)
If world crude oil prices get stabilised at lower levels and the turmoil in the Middle East and West Asia is out of the way in a short period, the happenings in the latter half of 2011-12 should not be embarrassing.
Even if, according to the RBI, it is desirable to have slower growth with a view to tackling long term inflationary pressures, there should not be any disinclination to review the monetary policy after October especially, as the calculations of the Union Finance Ministry relating to the collection of indirect taxes should not be adversely affected. Also, reduced availability for domestic consumers and continuing brisk exports should not be inhibited due to slower industrial growth.
Tax collections
Any heavy shortfall in tax revenues over the budget estimate will get reflected in a higher fiscal deficit if it also becomes difficult to realise the anticipated proceeds of Rs.40,000 crore under the disinvestment programme. It will not be possible to ensure success of offers of sale by public sector units if the bourses continue to remain depressed and fresh forex inflows are not at the desired rate.
The decisions of the RBI and other developments brought about a steep drop of over 1,400 points in the Bombay Stock Exchange Sensitive index.
P. A. SESHAN
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