Bringing back the confidence

When the government becomes weak, everybody starts talking. Now regulatory body chiefs and Reserve Bank deputy governors are all in the fray to make pubic pronouncement of what should be done. While SEBI chairman, U K Sinha, has advised government to fast track reforms programmes, if necessary side stepping parliament, two deputy governors are expressing contradictory opinion whether there should be a cut in the policy rates in the next review of monetary policy on 18 June.

While one of them, Subir Gokarn, said that there was scope for a rate cut as inflation has calmed down, the other K C Chakraborty, said there is no headroom for a cut now as inflation rate was still high. Sure, at the end of the day the head of the institution, RBI governor will overrule the two and decide on his own wisdom, as he had been known to do. But in the meantime the markets are going up and down following observations from these high functionaries, as the market feels their views will weigh on policy making. In the last two days, stock markets have gone up after one of them spoke favourably, and went down again when the other negated it.

In the midst of all this, the chief economic adviser, while delivering a lecture in Mumbai, urged the RBI to cut rates to stimulate growth. In the context of the overall uncertainty in the outlook with Europe still grappling for a solution to the Greek and increasingly the Spanish crises, there is need for some push to growth. There is no doubt now that the economy has slowed down. The latest figures clearly indicate the slide with growth coming down to 5.3 per cent in the fourth quarter of 2011-12 compared with 8 per cent in the first quarter. The numbers apart, there is much less enthusiasm about India and its growth story now than even a year back.

There should be a rate cut at least for three reasons at this point of time.

A rate cut at this stage could give a leg up to the overall sentiment. This is important.

Fundamentally, the Indian economy continues to be resilient and strong. With large stocks of food grains, at least a major part of inflation worry is not on hand. The economy has seen a sharp drop in investment. Large investments have to factor in the interest costs and for such investments interest cost, and more critically, the future expectations about interest, plays a critical role. True, investments have been held up for very many other reasons, such as, lack of clearances and availability of land for projects. Aggravating investment sentiment with high interest rates need not be the first thing that we should carry on with now.

Anyone saying interest costs does not have a bearing and the costs are small must be talking from a banking ivory tower. The policy rate at 8 per cent translates into above 13 per cent rate for borrowers. Even for education loans, the banks are charging 12 per cent interest rate. For large corporates, who are in the best category, the rates are not less than 13 per cent. For the average, it is 14 per cent. If these are not prohibitively high rates of interest what are? True compared to credit card rates of 36 per cent, these are low. But are we aiming for such rates in pursuit of inflation control?

Thirdly, as we have seen, Indian inflation is mainly food inflation which transmits into the rest of the economy. Typically, food inflation has been seen to be immune to interest rate instruments. As has been observed for one and a half years, the food prices went up in step with interest rate hikes, they started falling in the winter months when arrivals of vegetables were plentiful in the markets. Indeed, prices had crashed for all vegetables and during November end till February end, prices of vegetables - which had shown highest and persistent rise - continued to fall. Despite these clear facts, RBI’s monetary purists have to keep on arguing about high interest regime for inflation control. It is almost abject subjugation to some received ideas, completely devoid of the notion that some reexamination may be in order.

That component of inflation which is somewhat amenable to monetary instruments, manufacturing goods prices, have shown softening tendencies recently. These are hovering around 5 per cent which is said to be the comfortable level for RBI. While, overall inflation rate is at around 7 per cent at present, with manufacturing goods inflation at 5 per cent, there is at least some space for a rate cut. This has been pointed out by deputy governor, Subir Gokarn, and there is merit in his observations. Chief Economic Adviser, Professor Kaushik Basu, has also pointed out the same factors, including the need for rate cut for growth stimulus.

A rate cut is important for another reason. The successive quarterly drops in growth rates clear show the importance of introducing some stimulus. It is difficult to immediately give some fiscal sops as the fiscal situation is grim. The only alternative instrument available is some kind of monetary stimulus and this could be in the form of a cut in the basic policy rates. As was seen earlier in November 2008, the Indian economy sprang back into life at the worst phase of the global melt-down, when a combined monetary-fiscal stimulus package was introduced.

There is every reason to believe that some stimulus to the economy at this hour should bring back the confidence and also the necessary push to send it back into a high growth trajectory. It is all more necessary to perk up our domestic economy, as one cannot be sure how the global economy will turn in the months ahead.
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