India would not be able to restore double digit growth with creation of jobs in the economy and revive the sagging exports unless the interest rates are eased. People may hope the new governor and the monetary policy committee to be constituted would take care
The nation can now hope for resilience and restoration of growth in the economy with the exit of Rajan, followed by shifting of power of periodic review of monetary policy, to a six member “Monetary Policy Committee (MPC)”, instead of continuing to allow the Governor of Reserve Bank of India (RBI) to have sole discretion over it. The Modi government had to amend the Reserve Bank of India Act in June-2016, to transfer the governor’s sole, arbitrary and discretionary authority of periodical review of country’s monetary policy to this yet to be constituted 6 members committee. This timely change to take care of country’s monetary policy, in tune with the global trend, at a time, when many countries have slashed their interest rates, to near zero or negative to boost their growth rates, exports and investments, would certainly enable the nation to attain requisite economic resilience. The way Rajan has stuck to a very tight monetary policy and high repo rates, culminating into a 12 per cent or even higher interest rates for borrowers has caused worst ever industrial sickness, decline in exports and a financial logjam in economy, even when the Whole Sale Price Index (WPI) has turned negative in India since end of 2014 to felicitate a major rate cut. As a consequence of hawkish and inflation-bashing monetary policy, characterised with high interest rates, the investments, employment generation, corporate growth and credit off-take in the economy have come to a near halt. Consequent negative trend in exports, growing industrial sickness, burgeoning Non-Performing Assets (NPA’s) of banks, declining credit off-take and unprecedented abandonment of new projects in pipeline have culminated as a consequence of such high interest rates in disregard of the global trend. Almost 12 precious years appear to have been lost by the country, under the hawkish attempts of 3 successive governors, to scuttle growth by holding exorbitantly high interest rates, in the name of inflation-bashing, since March 2004, when the repo rate was raised from 6 to 6.25 per cent at a time when all major economic powers were
moving in opposite direction and are now having near zero or even negative interest rates. Repo rate was even raised to 9 per cent in July 2009. Now Rajan has also held the rate at 6.5 per cent ignoring contemporary
competitive global scenario.
In today’s open and globalised economy, when goods and capital have free mobility from across the borders, pursuing such a tight monetary policy with high interest rates in complete disregard of the near zero of even negative or interest rates of several countries has led the economy of Bharat to such a state of mess. Exports have fallen straight through the last 20 months, except in June 2016, inter alia, due to high cost of borrowings. Companies are turning non-competitive and sick, one after the other, offering themselves as an easy prey for takeover by foreign MNC’s due to higher interest burden. Non-Performing Assets (NPA’s) of banks have peaked to turn growth in the credit off-take from banks to
negative. New projects and fresh investments have badly dampened to the worst ever state of the post-independence period, and projects worth Rs 8, 80,000 crores have been abandoned by most of the promoters. The loss of output and exports suffered by the country, deprivation of youth from
getting jobs in their precious age of working and the nation’s falling behind the other countries; not only like China, Korea and Malaysia but, even behind Bangladesh, Philippines and Vietnam in matters of certain exports and industry performance, is a serious cause of concern.
Indeed, barring two short spans of high inflation viz. from March to December 2008 (for 8 months) and from December 2009 to April 2010 (for another 5 months) the inflation had never been so high to warrant such a high repo rate. Even the WPI has turned negative since end of 2014. Yet, Rajan has stubbornly stuck to his stance for very high interest rates regime. He has altogether ignored the virtually zero GDP deflator in the economy, accelerating bankruptcies in corporate sector, growing industrial sickness, in the country out of competition from cheap imports from low interest-rate countries, import surges of cheap goods, collapse of exports, near zero growth in employment, burgeoning NPAs, near total abandonment of most of the project proposals, log-jammed financial system and near halt of private investments in the economy. Instead of conceding the reality when, company after company has been bleeding against cheap imports and loss of export markets, largely due to heavy borrowing costs, arising out of high interest rates in the country, he begun alleging the industry of having greed and blamed entrepreneurs devoid of ambition and scruple, who had
borrowed heavily instead of issuing shares just to monopolise profits and avoid dilution of control over
management. On the other hand when, as a consequence and after a year, bad loans began to log-jam-banking resources, due to industrial sickness, he began to accuse bank managers of corporate cronyism and incompetence. He had been the Chief Economic Advisor of the International Monetary Fund (IMF), before coming to India and joining Manmohan Singh Government as the Honorary Economic Advisor in 2008, (and Chief Economic Advisor thereafter from 2012 and now Governor of RBI since 2013) and familiar with the practices prevalent in industrialist countries.
Indeed, growth mostly accompanies, when there is a bit of inflation. Monetary expansion is often seen as a good means to enhance investments, employment, output, raise per capita availability of goods and services, generate demand, raise consumption-creating further impetus for investments, employment and demand etc., which may perpetuate ultimate self-sustained growth. Without mild inflation in the economy, how can investments come?. The South Korea had average 7.6 inflation throughout preceding 5 decades, yet they posted more robust growth, by a very low interest rate regime. The inflation had even touched to 28 per cent but, they achieved a more robust development than China, by pursing a liberal monetary policy and low interest rate regime. The South Korea has just 5 per cent of our area and population. But, it has 24 per cent share in world ship building, while India has less than 0.1 per cent contribution in world ship-building, inspite of being world’s 4th largest steel producer.
Indeed in the course of raising repo rates since March 2004, it was raised from 6 to 6.25 and was thereafter taken to 9 per cent by July 29, 2008. Again after bringing it down to 4.5 per cent by April 21, 2009, to avert the impact of down melt the rate was raised again to 6 per cent by September 16, 2010, and then to 8.50 per cent on October 25, 2011. The inflation in India had even turned negative in the end 2014, which had been so, till July 2016 except one month of July 2016. Yet the RBI kept Repo rates at 7.75 per cent in January 2015 and has now been holding the rate at 6.50 since April 2016, while keeping it unchanged in his last review of August 9, 2016.
One should not forget that, in the globalised economy, the prices in India are less influenced by money supply and more by scarcities and external variables. The high CPI in June 2016 is due to higher food prices, wherein the pulses, prices have shot up due to shortage in production. Otherwise also, the inflation in India, in all these years had been high due to external variables viz:
(i) Huge inflow of Foreign Institutional Investor (FII) investments leading to higher commodity prices.
(ii) Decline of Rs exchange rate from Rs 50 per USD in 2011 to Rs 66.6 per USD in 2016, leading to higher prices of all imports in Rupee terms, where the imports into India are 27 per cent of our GDP. The exchange rate of Re has fallen due to higher trade, current account, and investment income deficits.
(iii) Poor availability of essential items due to shortfalls in output. To improve the supply side, a liberal monetary policy is the need of hour. Even a farmer would dare to borrow money for farm implants and inputs for raising output, if interest rates are low.
If the interest rates are lowered the size of installment comes down for both households and corporate to facilitate them to undertake expenditure and investments respectively, to fuel growth. Monetary expansion and growth in money supply is necessary to provide funds for investment employment generation, consumption growth and creation of demand leading to further investment, employment etc to perpetuate a phrase of self-sustained growth and development.
The tight monetary policy of Rajan and his two predecessors had little influence over price rise due to lack of any geo-political barriers in the post globalised economy. Due to quantitative easing (QE) by the US to the extent of USD 2 trillion after the global melt down along with the similar QE in Japan and EU the FII investment into India has nearly trebled. Between 2001 to 2007 India received USD 60 billion as portfolio investment, which shooted to USD 162 billion in the six year period between 2009-15, fueling
commodity prices to shoot up inflation, which the RBI tried to control by strangulating domestic economy through higher interest rates. Likewise, when US fed reserve (Central Bank of US) raised interest rate by just 25 basis points in end 2015 this led to an
outflow of USD 735 billion from Emerging Market Economies (EMEs). India also experienced a net outflow of USD 3 billion in portfolio investment in 2015-16, posing threat to the Rupee value as we had a Current Account Deficit (CAD) of $22 billion and it would be safe as we could receive USD 44 billion as FDI. But, the country had to open FDI into 15 sectors in November 2015 and 9 sectors in June 2016 to sustain inflows of FDI. But, when we already have trade and current account deficits, then continuous inflow of FDI without matching outbound Direct Investments would worsen the Balance of Payments (BOP) due to growing deficit in investment income, which is already above USD 25 billion.
Therefore, the new governor of the RBI and the MPC to be put in place, have to evolve an integrated approach, keeping in view the global changes while shaping the new monetary
policy. In every case the interest rates need to be reduced with monetary easing for economic resilience, investments, employment generation and revival of exports. Reduction in interest rates may prove vulnerable for the senior citizens dependent on interest income. They may be safeguarded by retaining higher interest rates for senior citizens in post office savings or through some other Special Purpose Vehicle (SPV) for their savings. But, India would not be able to restore double digit growth with creation of jobs in the economy and revive the sagging exports unless the interest rates are eased. People may hope the new Governor and the monetary policy committee to be constituted would take care.
(The writer is vice-Chancellor of the Pacific Academy of Higher Education and Research, Udaipur, Rajasthan)