Political factors

RBI ANNUAL POLICY 2004-05/ MARKET MEASURES - PRESSURE POINTS

Privatisation and labour reforms are likely to be the first casualty of the new government at the Centre to be run by the Congress-led United Progressive Alliance.

Even though the economic agenda (or the common minimum programme) of the ruling parties is yet to be chalked out, some of the constituents have started talking about increasing subsidies at various sectors, bringing down the prices of kerosene and diesel, and raising interest rates for small savings.

Caught in the cross-fire, the Reserve Bank of India (RBI) will be required to do a tough balancing act.

To meet the increasing social sector spending, the new government may take a relook at the excise and tax structure.

However, that alone may not be enough to generate sufficient revenue. In that case, the annual borrowing programme of the Union government is bound to go up.

This is likely as the government may not follow the revenue stream "" disinvestment of the government stake in public sector undertakings which had generated over Rs 15,000 crore last fiscal year.

Faced with a higher borrowing programme, it will not be easy for the RBI to raise the interest rates as it will have an adverse impact on the cost of government borrowing.

At the same time, the pressure will be on raising the small savings and provident fund rates to benefit the common man. This may distort the interest rate architecture meticulously built by the finance ministry and the RBI over the last few years.

Excess liquidity

The first tranche under market stabilisation made its debut on April 6 and there have been successive issues till date to mop up around Rs 14,000 crore from the system.

The first few days after the introduction of MSS and modified liquidity adjustment facility (LAF) witnessed decreasing volumes of liquidity in repos, tenure of which has been extended from a day to seven days, while the rates have been kept unchanged at 4.5 per cent.

The main source of liquidity is the huge flow of foreign exchange and the Reserve Bank of India's sterilisation operation. For every dollar RBI buys from the market, an equivalent amount of rupee gets into the system adding to the liquidity.

However, with the exit of NDA government, there is a distinct slowdown in the foreign exchange inflows.