We need to keep in mind that there is a confluence of factors and developments — both external and domestic — that forms the backdrop for this development. The firming of yields abroad because of the changes in the stance of systemic central banks, especially the US Federal Reserve, and other fiscal developments in the US, has been significant. So, over the last six weeks, the US 10-year yields have hardened by 40-50 basis points (bps) — a fair bit of movement.
Also, over the last six months, domestic inflation has increased in part, of course, because of hardening crude prices. Coming to domestic factors, because of the uptick in economic growth, there are now competing demands for financial capital that put upward pressure on all returns. We have news
of fiscal slippages at three levels in recent times — this year, next year compared to what the market expected, and what the target was, and then, a postponement of the medium-term adjustment even further. So, if you look at all these factors, I think it is clear which way the bond yields are likely to move.
Why do you think the investment-GDP ratio is still subdued?
We should expect the investment-GDP ratio to improve and there are incipient signs for it. The first discernible sign would be existing capacity utilisation reaching a certain level. The credit offtake is now in double digits, albeit low, after a long time. So, the movement in both will result in the improvement of the investment-GDP ratio.
The other thing we need to keep in mind is that the taxation on capital in India is from several sources, and then at the marginal rate, it adds up. So, you have a corporate tax rate, dividend distribution tax rate for dividend income above Rs 1 million, marginal tax rate, securities transaction tax, and capital gains tax. Thus, there are five taxes on capital, and that would obviously have an impact on investment and savings decisions.
Why was there no shift in stance? What would warrant a shift in the stance?
Patel: We look at inflation projections longer than what was happening this quarter... that rate (inflation) includes 35 bps of house rent allowance (HRA recommendation of the Seventh Pay Commission), so that needs to be taken off. If you look at our 2018-19 forecasts, and make the adjustments for HRA going forward, the inflation rates are still around 4.5 per cent. In some quarters, it might still be a little higher. Taking all that into account, we felt that without more data coming in, it was not necessary to change the repo rate or the stance.
Do you see inflationary risks building up as we go forward?
Our decision taken today (Wednesday) is based on our projections, and those projections indicate that there may be a slight rise in inflation this quarter. But during 2018-19, it will remain around 4.5 per cent, which is why there was no reason to change the monetary policy at this point — and over the coming three to four months. Depending on the data we receive, we will take decisions.
With fiscal deficit target of 3 per cent in FY21, to what extent is this going to impinge on your ability to pin inflation rate to 4 per cent in a durable fashion? Won’t that necessitate a tighter monetary policy?
Patel: There are several pre-conditions that were in the report. We also need to be mindful that even when the fiscal deficit has stayed above 3 per cent, inflation has come down to some extent because the fiscal stance — starting from 2014 — has actually been on a downward trajectory. Secondly, the monetary policy has become much more flexible in terms of responding to inflation risks. So, it is not necessary that 3 per cent should be achievable by the time the report says it would be. However, having a fiscal stance that is conducive to achieving the 4 per cent target is important and significant, and to postpone deviations from them would make matters more challenging in the future.
How will the Budget decision to procure agri-produce at 1.5 times the minimum support price impact the economy? Have you accounted for it?
We are still awaiting some of the specifics on that in terms of costing. In the coming weeks, as more information comes on exactly which crops are going to be supported and to what extent, we will have a better idea of the impact. We have said there could be an impact, but we have not said how much — whether it is going to be more or less. At the moment, there is not enough information to figure out what the costing would be.
Finance Minister Arun Jaitley says the government would be amending the RBI Act to introduce the standing deposit facility (SDF). What could be its structure and rate? Would you be using SDF after the market stabilisation scheme matures in March?
Executive Director Michael Patra: Currently, the SDF will just be an additional liquidity management instrument to add to our arsenal. The exact details will be worked out as and when introduced. As you know, it is still a Budget proposal and it intends to make the liquidity management procedure symmetrical. As of now it is asymmetrical: You have two instruments of injection but only one instrument of absorption.
Has the RBI shared its dividend with the government?
Patel: We always shared the dividend with the government, and we have already done that for this year. It is something that is done in a mechanical way. Our financial year is from July to June, so we are halfway through it.