The Reserve Bank of India, today released the Monsoon 2010 issue of its Occasional Papers. Occasional Papers, a research journal of the Reserve Bank, contains contributions of its staff and reflects the views of the authors. This issue is woven around some important themes which have been at the forefront of policy discussions. The issue contains articles, special notes and a book review.

Potential Inflation Risk should motivate Faster Return to Fiscal Consolidation

The paper titled ‘Global Crisis, Fiscal Response and Medium-term Risks to Inflation in India’ by Jeevan Kumar Khundrakpam and Sitikantha Pattanaik  has examined the empirical relationship between fiscal deficit and inflation over the pre-Fiscal Responsibility and Budget Management (FRBM) period 1953-2005 as well as the total sample period of 1953-2009. The authors study the direct impact of fiscal deficit through primary expansion in reserve money by using a concept of ‘seigniorage’, proxied by the annual change in reserve money deflated by WPI inflation.

Empirical estimates suggest that one percentage point increase in the level of the fiscal deficit could cause about a quarter of a percentage point increase in the Wholesale Price Index (WPI) over time, though the impact in the short-run may  be modest at only 0.04 percentage points. The paper emphasises that the potential inflation risk should work as an important motivating force to ensure a faster return to the fiscal consolidation path in India. The process according to the authors should be driven by adjustment based on appropriate rationalisation of expenditure, rather than waiting for the job to be done automatically through revenue buoyancy associated with sustained robust growth. The paper argues that in Indian context the fiscal policy should not only play the usual  role of stabilising output but also in occasionally containing inflationary pressures that often arise from temporary but large supply shocks..

Efficient Funds Management and Other Income make Foreign Banks Profitable

Under the section on Special Notes, the paper ‘Profitability of Foreign Banks vis-à-vis other Bank Groups in  India – A Panel Data Analysis’ by  Rakhe P.B analyses the financial performance of foreign banks in comparison with other bank groups in India. The paper assumes importance in the context of the on-going preparation of roadmap for the presence of foreign banks in India by the Reserve Bank. The results of the study indicate that access to low cost funds, diversification of income and access to other income sources to fully finance the operating expenses are important factors leading to higher profitability of foreign banks vis-à-vis other bank groups in India. The results of the panel data regression also indicate that efficiency of fund management is the most important factor determining profitability in the banking system followed by generation of other income. The paper also suggests that a holistic view needs to be taken on foreign banks policy, by considering factors such as global financial inter-linkages, financial performance of parent banks as well as the pursuit of social objectives by these banks.

Technical Studies

The Occasional Papers also contain two technical studies.

The paper on ‘Forecasting Inflation and IIP Growth: Bayesian Vector Autoregressive Model’ by Dipankar Biswas, Sanjay Singh and Arti Sinha attempts to develop a VAR as well as Bayesian VAR (BVAR) model for forecasting inflation as well as IIP growth using quarterly data on WPI, IIP and M1 since first quarter of 1994-95 to fourth quarter of 2007-08. Comparing the performance of these two models, the authors find that the forecasts, measured in terms of out-of-sample percentage root mean square error of VAR model being used for forecasting inflation as well as IIP growth, improve by applying Bayesian technique.

The paper ‘Macroeconomic Forecasting using Dynamic Factor Models’ by  Sanjib Bordoloi, Dipankar Biswas, Sanjay Singh, Ujjwal K. Manna and Seema Saggar attempts to develop Dynamic Factor Models (DFM) to forecast industrial production and price level in India. For this purpose, economic indicators that contain information about the future movements of industrial production/ price level are selected. From the empirical analysis, it appears that the performances of DFM are quite encouraging. It also finds that the out-of-sample forecast accuracy of DFM, as measured by root mean square percentage error, is better than the OLS regression.

Book Review

Shri A. Karunagaran reviews the book titled ‘The Economic Crisis and The State of Economics’ edited by Robert Skidelsky and Christian Westerlind Wigstrom, Palgrave-Macmillan, USA.

The recent global financial crisis, not only kicked up the debate on the international financial crisis per se, but has been termed as ‘moral crisis of capitalism’ and is also compared with the ‘Great Depression’. Predictably scores of conferences, symposiums have been conducted by different forums across the world to seek explanations on it. This book is collection of papers presented in one such symposium organised in February 2009. The participants in the symposium were renowned economists, who came out with divergent views not only on the causes of crises but also on the very subject ‘economics’. This book is a compilation of neatly edited and presented conference papers. Shri Karunagaran, however, also feels that given the pre-eminence of authors, they could have made more explicit suggestions or suggested precautions to prevent such crises in future.

R. R. Sinha
Deputy General Manager

Press Release : 2010-2011/1114