Monetary Policy: Rate cut will achieve little

Dr Raghuram Rajan, Chief Economic Adviser to the Government of India, is the latest to chip in with advice to the RBI: cut interest rates.

Surprising, even astonishing. For he belongs to that bastion of monetarist orthodoxy, the University of Chicago. And, if one’s recollection is right, some time back, he had warned of the risks from the US Fed’s addiction to zero interest rates.

Inflation data do not support the case, with recent falls in the WPI yet to be reflected in the CPI.

How and why then the sudden change? Is the Indian economy — with 5 per cent plus growth — in more depressed condition than the US? Or have Delhi’s mandarins made him change philosophy? Most important, what will a rate cut achieve?

Slowing investment

Investment has undoubtedly slowed down. The question is if it is attributable to ‘high’ interest rates. It’s true that the captains of industry and chambers of commerce are demanding lower rates.

They have been joined by the CEOs of banks (who are generally content to heap praise on the Finance Minister after every Budget and the RBI Governor after every monetary policy announcement).

The cost of bank credit remains extraordinarily high for small business enterprises, whatever be the tone and trend of interest rates and yields in bond markets. In effect, they are different worlds.

Even credit for SMEs is hard to come by. Loans of Rs 5000 crore are collateralised with ‘franchise’ and ‘brand’ ‘values’ (with a rating, an audit or a consulting firm supplying a ‘convenient’ valuation), while a Rs 5-lakh loan must be secured by several times that amount.

To be fair, the situation is no different in the US and the UK.

There seems little point in lowering interest rates if they are not passed through to SMEs.

Their investment decisions are more sensitive and elastic to the cost of money and they have more employment potential than large-scale industry.

Is there awareness of and an actionable plan for this in the Government and the RBI?

Sustainable growth

Infrastructure investment has taken a big knock for a host of reasons unrelated to interest rates.

One wonders how many in policy circles pushing for softer rates know that output pricing in power and road projects is cost plus, with interest as a given and, therefore, irrelevant.

So there is very little that the RBI can do to boost investment where it is vitally needed.

The consumption part of GDP is growing nicely. The downside is that it is import-intensive, adding to the trade deficit and, therefore, GDP subtracting.

The lesson, entirely lost on the powers-that-be: we need sustainable growth, encompassing human development indices, energy and environment.

If we get the ‘whole’ right, the monetary and fiscal bits will fall in place easily.

Naive monetary prescriptions will get us nowhere.

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