Impediments to economic transmission

Monetary and fiscal policy should go in tandem to create better economic impact

An economy is like many images of an elephant to blindfolded men. And the Indian economy is considered unique in many ways, especially when it comes to working of many traditional economic measures such as reduction in interest rates, inflation and growth balancing.

We see different groups arguing for holding up rates and reduction of rates at the same time. While corporates consider low inflation as the cause for low revenue growth, consumers view inflation to be on the higher side. These factors act as impediments to economic transmission and they affect normal working of economic levers.

Monetary issues

The most visible impediment is the presence of differential rates which are de-linked to the economy and are an inhibition to money flow.

One example is the availability of Public Provident Fund (PPF) at 8.1 per cent and the Employee Provident Fund (EPF) at 8.8 per cent.

These are at a much higher rate than Fixed Deposits (FD) rates which vary between 7 and 7.5 per cent per annum. For some periods the returns on these schemes may even surpass those on debt mutual funds. Similarly, some tax-free bonds offer significantly higher post-tax yields as compared to fixed deposits.

This distorts savers’ preferences towards various asset classes. Typically, long-term savings instruments should relate closely to the interest rate scenario in the country. As an example, government securities’ yield for three years is at 6.90 per cent and 15-year paper yields at 7.20 per cent, both on a semi-annual basis. The difference arises because of the premium the savers demand for investing for a longer period (technically called term premium).

But, the current 130 bps term premium (EPF rate v FD rate) is much higher than 30 bps in other liquid assets like Government securities. With small saving schemes like National Savings Certificates (NSC) and Monthly Income Schemes (MIS) linked to government security rates, it is a worrying sign that EPF rates are still not linked to any market variable.

Also, banks which are under pressure due to asset quality, are concentrating on low-risk assets. This has affected money flow to viable borrowers as well. Some of this low-risk approach is somewhat similar to the developed market banks (such as the US and European banks) which failed to re-engage in credit disbursement despite massive monetary easing.

This weak credit growth scenario of Indian banks should get better over the next few quarters as the problems with non-performing assets improve.

Real Economy marred

Besides these two monetary issues, monopolistic power among economic participants continues to create unintended consequences of scuttling competition and creating disparity in economic compensation to participants.

A glaring example of the same is the Agriculture Produce Market Committee (APMC) Act, which allows traders to avail huge margins due to cartelisation, whereas both the consumers and producers are at the receiving end; 30 plus per cent of cost to consumers is a commission fee and over 30 per cent is margin of the traders/retailers.

This distorts the allocation of capital and we see nearly a complete breakdown of farm economy. In addition to this, market access is also troubled due to information asymmetry, differential tax regimes across States, unavailability of transport and storage infrastructure which at times leads to time losses, cost escalation and loss of perishable items. Differential tax regime is expected to largely get addressed through the recently introduced Goods and Services Tax.

Each of the impediments needs to be addressed in depth to make economic levers act swiftly. The Government has taken steps to link all economic rates, address the issue of black economy with the objective of bringing the unused money in the mainstream, remove APMC and better targeting of subsidies through measures like direct benefit transfer and use of JAM.

However, measures like Goods and Services Tax (GST), linking of remaining unlinked rates (especially EPF) to markets, development of transport and storage infrastructure should help in removing these impediments and lead to faster growth of the economy.

The writer is Head - Fixed Income, HSBC Asset Management Private Limited

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