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The Reserve Bank of India, the country's central bank, has warned the government that the fiscal deficit may overshoot its target of 4.5 per cent of GDP (gross domestic product) in the current financial year, as expenditure may be more than what has been budgeted for, while revenue may be less than expected, even though the projected growth will be in the 6 to 7 per cent region.

The dire warning was contained in the RBI's Annual Report for 1996-97, which was released in Bombay on Sunday, September 7. The RBI ended its last financial year on June 30, 1997.

The RBI is clearly worried about the Centre's financial condition. It has warned that the target of keeping the fiscal deficit below 4.5 per cent this year may be unachievable since "there are some indications of the likelihood of expenditure overshooting and possible decline in revenues anticipated. Any overshooting in expenditure or reduction in anticipated revenue will put to severe test the government's ability to lower the fiscal deficit."

Given the central bank's understated style, this more likely means the Centre's finances are in quite a bad shape. The RBI's annual report has used relatively strong words to call for a "more credible fiscal reform programme", a "qualitatively improved fiscal correction strategy", and for "immediately...placing limits on public debt within the purview of the existing constitutional provisions."

The RBI report has also warned that large government borrowings and the use of oil bonds by oil companies to raise funds from the market would exert upward pressure on interest rates.

"Conversion of the (oil pool) deficit into any form of government debt would amount to an increase in borrowing by the government and put additional pressure on the market with its inevitable impact on interest rate, if any part of it is liquidated by the oil companies in the market to raise resources." The report appears to have been written before the central government announced the hike in petroleum prices on September 2, when it also announced the issue of bonds to oil companies.

According to the RBI, the government's gross borrowings during 1997-98 are estimated at Rs 529.63 billion with net borrowings estimated at Rs 338.2 billion as against Rs 263.56 billion in 1996-97.

The repayments of past loans at Rs 191.43 billion alone constitutes about 36 per cent of the gross borrowings. According to the central bank, the growing size of the government debt has led to a bunching of repayments besides concentrating the borrowings at the shorter end of the maturity spectrum. This will have its effect on the interest rate structure, the central bank has noted.

With the double warnings, the RBI has said that "some hard decisions on subsidies and administered prices are inevitable.''

The RBI has suggested that the government shift its expenditure to the crucial social and infrastructure sectors. ``It is now time for evolving a strong and qualitatively improved fiscal correction strategy with an accent on achieving further compression in fiscal deficit,'' the report says.

The Reserve Bank has called for restructuring of agricultural subsidies and scrapping food subsidy for those above the poverty line. It has also called for the introduction of futures trading in specific commodities to lessen the price volatility in these items.

The central bank has called for a reduction in both explicit and implicit subsidies in the non-merit goods sectors so as to bring down the level of non-interest revenue expenditure. One of the subsidies recommended for pruning is the food subsidy for persons over the poverty line.

It has emphasised the need to pare non-interest revenue expenditure, and slash "explicing and implicit" subsidies in the "non-merit goods" sector. A small increase in the recovery rate in this sector -- currently pegged at 12.1 per cent -- will lead to a reduction in the fiscal deficit to GDP ratio.

The Reserve Bank has stated, the existing system of subsidising agricultural inputs would need restructuring so that direct investment in productive assets, particularly in irrigation, power and rural roads could increase.

The apex bank has also stated that to minimise the extent of price volatility in agricultural products, futures trading in specific commodities would need to be pursued vigorously. The RBI also feels the need for further opening up of agricultural product markets through the removal of control and regulations such as those imposed on interstate movement, exports, trade storage to help empower the farmers and to realise more remunerative and profitable returns on their products.

Agricultural products occupy a prominent place in India's external trade, accounting for nearly 20 per cent of total exports and, therefore, warrants special thrust in overall export promotion efforts.

Nevertheless, the RBI is positive about economic growth. There is hope for a turnaround in industrial fortunes thanks to a buoyant growth in agricultural production, a cut in tax rates, and a rise in the domestic household savings. The onus, however, of achieving the 6-7 per cent GDP growth target in 1997-98 rests squarely on the shoulders of industry.

The only constraint that can hold back industrial output would be infrastructural bottlenecks. Industry and steady exports hold the key, since agriculture, after soaring last year, is unlikely to post that kind of growth again this year. The expected increase in world trade volume in 1997 should provide avenues for a pick up export demand. The RBI has stated that adequate attention needs to be paid also to industry specific and destination specific factors.

The RBI has stated that several incentives for the corporate sector provided in the budget 1997-98 could facilitate resurgence in industrial activity in the current year. A reduction in interest rates following the monetary and credit policy of Reserve Bank for the first half of 1997-98 may also be expected to boost aggregate production.

The Reserve Bank has sought a more credible fiscal reform programme to control increasing debt and interest payments. In this context, the RBI said consideration should be given for placing a statutory ceiling on public debt. The Indian Constitution provides for placing a limit on public debt secured under the Consolidated Fund of India, but excludes other liabilities covered under the public account.

Ideally if a limit is contemplated, it should be on the total liabilities of the government, the RBI has said. Pending constitutional amendment, the government could immediately consider placing limits on public debt with the purview of the existing constitutional provision while mandatorily providing information to Parliament on other liabilities, contingent liabilities and overall public sector deficit, the RBI has suggested.

The RBI has also virtually accepted the recommendations of the Tarapore Committee on capital account convertibility. It is at a present looking at the committee's specific recommendations, which will become operational during 1997-98.

The Tarapore committee had indicated a liberalisation of capital account transactions spread over a period of three years in conjunction with certain preconditions to be achieved in this context.

However the Reserve bank has taken the view that it is not essential that liberalisation of capital account transactions should wait until all the preconditions are fully met. In some cases, liberalisation of capital account transactions can itself facilitate achieving of some of the preconditions. Therefore an eclectic approach should be to liberalise the capital account transaction even as the process of achieving some of the pre conditions is in progress, the RBI has stated.

The bank has shown its optimism over the healthy build-up of foreign exchange reserves. The $29.9 billion forex reserves (including gold and SDRs) logged as on August 14, 1997, (subsequently it crossed the $30 billion mark) is enough to finance seven months of imports and "well above the conventional thumb rule of reserve adequacy," the annual report claims.

The Reserve Bank feels it is useful to asses the level of reserves in terms of the volume of short-term debt which can be covered by the reserves. At the end of March 1997 the ratio of short-term debt to the level of reserves amounted to a little of reserves amounted to a little over 25 per cent, unlike the 220 per cent for Mexico, 150 per cent for Indonesia, and 30 per cent for Thailand.

Regarding the exchange rate management, the report favours short-term nominal appreciation during periods of excess dollar supply. But the authorities would have to be prepared for aggressive intervention, supported more often by equally aggressive sterilisation so as to defend the monetary objective, the report states.

The Reserve Bank has also shown its concern about the strain on states' resources on account of subsidies. The pay scale revision of civil services will further burden the state finances and the "problem of fiscal consolidation" will become more difficult, it said.

It has called for an overhauling of the existing mechanism of market borrowings by states in conformity with the financial sector reforms. While financially-sound states should access funds at market rates, it has recommended imposing a "stipulated level of borrowings" in the case of less developed states.

While maintaining infrastructure to be a problem area, the central bank has said that this problem is further aggravated by the cuts in government spending in the area. A case in point here is the steep fall in the growth rate of plan outlays from 30.9 per cent in 1993-94 to 6.3 per cent in 1995-96 and further to 4.9 per cent in 1996-97. The result: the power sector alone saw a yawning deficit of 11.5 per cent in 1996-97.

The RBI wants the government to inject resources for the completion of select projects. It has also stressed the need for a more transparent as well as definitive policy on ownership, regulation and financing to attract private sector interest in infrastructure. The private sector finds itself hamstrung by the non-transparent and complex regulatory environment and the legal and institutional framework. The other barriers include the virtual domination of the public sector in long-term contractual savings from the household sector and a lack of securitisation of debt.

The central bank appears bullish about the external front in the wake of healthy capital inflows. This has prompted it to concede that the current account deficit, which in other words, is the trade deficit, need no longer be a `speedbreaker' to the growth process. As for the adjustment of the capital account deficit upwards, the RBI has said that while present levels of current receipts at 15 per cent of GDP can sustain a 2 per cent deficit, efforts will have to be made to raise current receipts over the medium-term. This can be achieved by increased exports.

The country's central banks said it is high time the government evolved a "strong and qualitatively improved fiscal correction strategy" and started spending more on the "crucial social and infrastructure sectors". As a part of the fiscal correction, it has called for a raise in the tax-GDP ratio. With a comprehensive tax reform programme in place, the gross tax revenue-to-GDP ratio should improve from the budgeted level of 10.5 per cent in 1997-98, it feels.

As per the report, in April 1997, the general index rose by 9.8 per cent compared with 1.5 per cent in March 1997, and 6.6 per cent in 1996-97 as a whole. Similarly, the manufacturing output recorded a sharp increase of 11.7 per cent in April 1997, way ahead of the March 1997 levels of 1.5 per cent and 1996-97 levels of 7.9 per cent.

EXTERNAL LINK:
The Reserve Bank Annual Report for 1996-97

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