'Govt finances may not be as good as they appear'
Reserve Bank Governor YV Reddy on Monday said the Indian government’s finances might not be as good as they appear – comments that, experts said, could mean the central bank would persist with its tight money stance.
Just as Reddy made the comments at a seminar in New Delhi, State Bank of India – the country’s largest – said it was increasing interest rates on term deposits by up to 0.5 percentage points. Other banks might follow suit.
“The fiscal situation (at the Centre) is improving but there are underlying pressures which are not entirely evident in these numbers,” Reddy said.
The central government’s fiscal deficit has declined from 3.7 per cent of gross domestic product in 2006-07 to 3.1 per cent in 2007-08 and is expected to further drop to 2.5 per cent in the current fiscal year. But the deficit figures do not include oil subsidies, future payouts on farm loan waiver and impact of hefty salary hikes recommended by the Sixth Pay Commission.
The central government issued oil bonds worth Rs 35,000 crore to state-run oil companies in 2007-08 and the figure could significantly go up this year. Similarly, implementation of the Pay Commission report and the farm loan waiver would cost the government as much as Rs 51,000 crore, which has not been factored into the 2008-09 budget.
“He (Reddy) is pointing to the fact that the off-budget liabilities are growing over the past few months,” said Rajiv Kumar, chief executive, Indian Council of Research in International Economic Relations, a New Delhi based think tank. “This means that the fiscal deficit is larger than what we know.”
A higher fiscal deficit means more borrowing by the government that, in turn, could put upward pressure on lending rates. Moreover, a spike in inflation has already pushed the central bank to repeatedly raise key interest rate and hike cash reserve requirements (the money commercial banks need to keep with RBI) in a bid to suck extra cash from circulation.
Shortly after Reddy made the comments, bond prices fell as traders took it as a signal for continuation of the tight monetary policy.
“Interest rates are likely to remain under pressure,” said Ram Kumar, head of fixed income at Sundaram BNP Paribas AMC.