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Will RBI bite the bullet next month?

Will RBI bite the bullet next month?

Last week, while rolling back most of the fare hike proposals of his predecessor Dinesh Trivedi, railway minister Mukul Roy said he had to revise the proposals as “the concern for the poor man is overriding"; and by doing so, he was “biting another bullet, though of a different kind". Prime Minister Manmohan Singh had stressed the need on “biting the bullet" on subsidies after Pranab Mukherjee presented the national budget. Mukherjee, too, in his interviews with television channels ever since he presented the budget has been talking about “biting the bullet" to bring down the fiscal deficit.

To “bite the bullet" is to endure a painful or otherwise unpleasant situation that is seen as unavoidable. Before the days of effective anaesthetics, soldiers were given bullets to bite on to help them endure pain. Rudyard Kipling was the first person to use this expression in his 1891 novel The Light That Failed—“‘Steady, Dickie, steady!’ said the deep voice in his ear, and the grip tightened. ‘Bite on the bullet, old man, and don’t let them think you’re afraid.’"

With reforms being made the biggest casualty of coalition politics, foreign investors’ excitement about India is disappearing fast. One sign of this is weakening local currency. The rupee hit its lowest level against the dollar in two months last week and it will weaken further. After losing about 16% against the greenback last year, the rupee gained about 9% in first five weeks of this year but since 3 February’s close of 48.6950, it has lost at least 5% against the dollar, making it the second worst performing currency in Asia behind the yen. The main reason behind the fall in currency is slowing foreign fund flow. After a net outflow of $500 million in 2011, foreign institutional investors (FIIs) bought Indian shares, net of selling, worth $2.18 billion in January and $5.3 billion in February, but the flow dropped to $1.7 billion in March.

While the tweaking of tax norms will impact foreign direct investment, the government’s reluctance to “bite the bullet" on reforms is affecting portfolio investments. There is not too much of scope for attracting foreign money in debt too. As on 29 February, FIIs invested almost $15 billion in government debt (up to the ceiling for such investment); and a little less than $19 billion in corporate debt and debt mutual funds (the ceiling is $20 billion). Their investment in infrastructure so far has been about $2 billion against a ceiling of $25 million, but in this segment fund flow won’t be too much as FIIs do not want to stay invested for long, and in the bulk of infrastructure funds ($20 billion out of $25 billion) they need to invest at least for three years.

The current account deficit (CAD) as a proportion of India’s gross domestic product will be around 3.6% in fiscal 2012. This, along with drop in capital flows, will continue to put pressure on the rupee exchange rate. Between September and January, the Reserve Bank of India (RBI) sold $19.8 billion and another $1.3 billion in the forward market. In the process, close to 1.1 trillion has been drained out as for every dollar sold, an equivalent amount of rupee leaves the system. If higher import duty on gold slows import of the yellow metal and oil prices come down, CAD will improve. Meanwhile, RBI has resumed intervention in foreign exchange market and this will contribute to the liquidity scarcity in the system.

Tardy deposit growth

Meanwhile, the loan-to-deposit ratio in the banking system—76.65—has probably been the highest in history. Simply put, the banking system is giving 76.65 loan for every 100 worth of deposits. This gives the impression that banks are aggressive in giving loans but that has not been the case. The banks’ credit portfolio this year so far has grown by 13.8%. The primary reason behind the high loan-to-deposit ratio is lower deposit growth. This year, the deposit growth has been only 12.4%, lower than loan growth.

One explanation for the lower deposit growth could be that consumers are preferring to spend money than keeping it with banks as the real return from deposits has been negative with inflation ruling high. If indeed this is true, currency in circulation should have shot up hugely but that has not been the case.

Yet another reason could be large-scale loan restructuring by Indian banks. In some sense, every loan turns into a deposit, with a lag effect, as once a company raises loan, it spends the money and that money comes back to the system, through others, as deposits. But when banks restructure their loans, they do not lend fresh money; merely the maturity of a loan gets longer. Since no fresh money is given, the so-called money multiplier effect doesn’t work as nobody gets money to keep as deposits.

In this complex scenario, it will be interesting to see whether RBI bites the bullet on 17 April when it announces the annual monetary policy for fiscal 2013, although the meaning of this phrase could be totally different for the central bank and the government at this juncture.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Email your comments to

Also Read |Tamal Bandyopadhyay’s earlier columns

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