FROM BUSINESS WORLD OF 12 DECEMBER 2006
Just another
correction?
Sensex fell by
400 points on 11 December – it lost 2.9 per cent of its value in a single day.
Investors who have thrived with its heady rise must be worried whether this is
the end of the long rally. They may have forgotten that they had the same
thoughts seven months ago – between 15 and 18 May Sensex had lost 8.3 per cent.
Then it looked as if the end had finally come. But it reversed itself; today,
Sensex is 18 per cent above the low point of May. A fall, even of this magnitude,
is not necessarily, not even often the harbinger of doom.
What is new,
however, is the rising frequency of sizeable falls – to put it in market
jargon, a rise in volatility. At one time such volatility would have meant that
a Harshad Mehta or a Ketan Parekh was playing with the market. Now with Sebi
wielding the stick, that is unlikely. What the volatility signifies is that
investor opinion is getting divided on the level of Sensex – that a body of
opinion is emerging that the limit has been reached for now.
The reason for
the rise of doubt is also evident: Reserve Bank has in recent months become
increasingly concerned about the economy getting overheated, and has taken
steps to curb credit and raise interest rates. On 8 June it raised its repo and
reverse repo rates by 25 basis points. On 25 July it raised the reverse repo
rate again by 25 basis points. It has recently announced a rise in the cash
reserve ratio by 25 basis points from 23 December and a further similar rise on
6 January. The rise in CRR is unlikely to bite soon, for banks’ average cash
reserves are about 7 per cent. Reserve Bank is by no means in a mind to bring
an end to credit expansion. It is only doing its job of being cautious and
cautionary.
It is a job that
the finance minister refuses to share. As soon as Reserve Bank announced its
intention of raising the CRR, Mr Chidambaram said there was no need to worry:
that stock prices were at a historic high, and that only the bank stocks had
fallen, because of the rise in CRR. But he could not be finance minister and
contradict Reserve Bank; so he also said that inflation was too high and
Reserve Bank was trying to moderate it.
If he really
believes what he says, Mr Chidambaram should himself be lending his shoulder
and pulling down inflation. He has a powerful instrument for this purpose in
the budget – a weapon he must be ready to wield as 28 February approaches. He
has promised to eliminate the fiscal deficit by 2009 – the year when he will
demit office in the wake of the general elections – but he could do it faster. Central
revenue is increasing at more than twice the rate of rise of nominal GDP. So he
can eliminate the fiscal deficit next year if he wants. The deflationary impact
of the budget is much more direct than of the wimpish interest increases that
RBI essays. In a situation where a rise in exchange reserves is increasing the
money supply, banks are drowning in cash, and they care two hoots about RBI’s
sundry rate increases. But an excess of revenue over government expenditure directly
reduces cash supply; if it went far enough, the banks would have to wake up.
More importantly, a fiscal surplus reduces aggregate demand – just what is
needed in the present roaring boom.
Many will
dispute the wisdom of reining in the boom. Everyone from the Prime Minister
down thinks that we have earned the boom on account of the virtuous reforms he
did long ago. Everyone thinks that if we are to match China, we need an even
bigger and longer boom. The expansionist lobby is very powerful.
Hope lies in the
fact that Mr Chidambaram shares RBI’s concern over inflation. But when he wants
to bring it down from 5 to 4 per cent, he is being too modest. The aim should
be to bring it down to zero. Just imagine how much better life would be if
prices stopped rising. People would be able to keep cash under their mattresses
without worrying about its losing value. Pensioners would not have to keep
petitioning for a rise in their pensions. Interest rates would come down. The
balance of payments would gain strength. Zero inflation is an idea whose time
has come.
