Rock bottom rates

| Updated on July 09, 2012 Published on July 09, 2012

Rich overseas investors will invest in India only if it is seen as an economy with good growth prospects and a large enough investment pipeline.

Last week, the European Central Bank (ECB) slashed its lending and deposit rates by 0.25 percentage points each to respective record lows of 0.75 and zero per cent. A zero per cent deposit rate is a basically a signal to banks to lend to businesses or least to each other, rather than simply park their money with the ECB that will earn them no interest income at all. But it also indicates the desperation among European authorities to somehow infuse life into the region’s economies, following recent data that shows even its most solid performer, Germany, facing a marked slowdown. Moreover, with a resolution of the euro zone debt crisis nowhere in sight, the current ECB rates may well remain at these levels for considerable lengths of time. That would be similar to the US Federal Reserve targeting an interest rate range of zero to 0.25 per cent for banks holding surplus funds with it to lend to those in deficit – a policy that began in December 2008 and is expected to last till late 2014.

Such ultra-low policy rates in the US, Europe or Japan – where, too, the benchmark central bank rate has been maintained at 0.1 per cent since December 2008 – raises obvious questions on how long the Reserve Bank of India (RBI) here can persist with its lending (‘repo’) rate at 8 per cent now. Such wide interest rate differentials can, at one level, be seen as conducive for attracting capital inflows that India, no doubt, requires, given the massive $ 78 billion deficit on its current account external transactions in 2011-12. The fact that low interest rates in their countries would cause rich world investors, too, to search for better returns elsewhere makes it a perfect fit of sorts both ways. But that can happen only if India is seen to offer good growth prospects and a large enough investment pipeline into which these funds can be productively deployed.

Right now, that pipeline has virtually dried up, which, in turn, is linked largely to state of investor confidence in the country today. There can be no better indication of this than the National Highway Authority of India’s efforts to award 1,500 km of projects under the build, operate and transfer route during the last quarter attracted bids for a mere 100 km – even after offer of up to 40 per cent capital subsidy! To the extent high interest rates, by eating into the operating profits of companies, have dampened business sentiment and the overall inducement to invest, the RBI’s current monetary policy stance may actually prove counterproductive. That being so, maintenance of high interest rate differentials would only attract speculative, short-term capital flows, as opposed to more long-term investments that add to the country’s productive capacity.

Published on July 09, 2012
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