Dr Ashwani Mahajan
The Reserve Bank of India once again opted not to reduce the interest rate while declaring monetary policy on 30th October, 2012. By this act, the Bank has once again disappointed all those who were expecting a cut in the interest rates. Though the Reserve Bank of India has half-heartedly tried to increase the liquidity in the economy by reducing Cash Reserve Ratio, but this may not bring any reduction in the lending rates.
The industrial growth rate has been falling continuously for one and a half years and is nearing zero now. This has resulted in slowdown in the economy and fall in the GDP growth. International Monetary Fund (IMF) has reduced the estimates of growth rate to 4.9 per cent and even the government does not seem to be much hopeful of any revival in growth rate. It is to be noted that for the last ten years during the Tenth and Eleventh Five Year Plans, the growth rate had been around 8 per cent. In the very first year of the Twelfth Five Year Plan, such a big fall in the growth rate of GDP is not a good omen for the economy. This fall has not only reduced the possibility of increasing common people’s income but is also likely to slow down the demand of products, services and even houses. Besides this, the fall in the production may make inflation rate, which has already reached 8 per cent, take an ugly turn.
The government has announced various measures to deal with the slowdown in the economy. The thinking of our policy makers is that the only way to deal with any problem in the economy is foreign investment. Due to this, without paying heed to unprecedented political opposition, the government announced the opening up of foreign direct investment in multi-brand retail and pension funds; and hike in FDI limit in insurance. In 2008-2009, the government of India used various fiscal measures to deal with repercussions of recession in USA and Europe on our country. Government expenditure was increased, simultaneously; taxes were reduced to ensure stability in the demand.
Indian economy is different from the rest of the world, and when in 2008-2009, the GDP of developed countries decreased by 2-3 per cent, the growth of GDP of India remained around 7 per cent. During the recession, which began in 2008-09, the governments of USA, Europe and India had the option to increase their expenditure. In US alone, bail out packages worth more than 1600 billion dollars was given. The government of India too, giving dam to FRBM Act, used heavy bail-out packages. Today, there is no possibility of such methods to uplift the economy, given huge fiscal deficit, nearing 6 percent in 2011-12. In this scenario, increase in government expenditure and decrease in taxes was not a practical solution. It can be said that fiscal measures have already reached utmost limits.
Misapprehension of the Reserve Bank
In the last two years, the Reserve Bank by increasing interest rates thirteen times ( with only one exception when it reduced the interest rates) ,increasing reporate to 8.25 per cent and reverse reporate to 7.25 per cent, has put an end to the possibilities of increasing demand in the country. When every month, the Reserve Bank of India announces its Monetary Policy, economic analysts expect a rate cut by RBI, just to get disappointed. The same happened after the declaration of Monetary Policy on 30th October as well. For the last two years, in spite of continuous increase in the interest rates, the rate of inflation has been accelerating. However, it does not seem to restrain the Reserve Bank from tightening its monetary policy.
Monetary Policy: The Only Solution
Though the argument of curbing inflation is correct yet the inflation rate is not obliging the RBI by coming down even slightly. This is also true that in the absence of fiscal measures, there is no other option except Monetary Policy, to increase the demand in the country. There are two demerits if the government tries to increase the demand by increasing its expenditure or reducing the taxes. One, the increase in fiscal deficit would lead to increase in the debts on the government which may further lead to increase in interest burden of the government. Secondly, with the slowdown in GDP, the increase in demand may force the inflation to take a scarier form.
However, the reduction in the interest rate by the Reserve Bank may prove to be a healthier solution for increasing the demand in the country. It is noted that in the early part of the last decade, reduction in the interest rates not only increased the demand in the country but also increased the investment demand. At that time, infrastructure of various types including roads, bridges etc. could take birth thanks to lower borrowing cost. Due to lower interest rates, there was a high increase in the demand of automobiles, other consumer goods and even houses. When the economy got the support of the demand, the growth rate which was earlier 5 per cent had reached 7 per cent. The inflation rate also remained between 3 to 4 per cent.
It is the time to repeat the same policy. This could be an excellent way to deal with the stagnancy in the demand of automobiles, other consumer durables and houses. The decrease in interest rate would not only increase the demand of automobiles and other consumer goods but even attract investors to make new investments. The scenario of India is such that there has been a fast increase in the incomes of the people during the last ten years. Our per capita income has reached around nearly rupees 60,600 in 2011-12. Therefore, increasing the demand of the country by reducing the interest rates is a wonderful measure to accelerate the growth of the economy. For the past few years, the middle class has been avoiding making new purchases due to the increase in the EMIs of the previous loans. Therefore, reduction in the interest rate by the Reserve Bank would lead to a reduction in their EMIs as well, which would encourage them to make new purchases.
Industrial Growth Too May Get a Boost
Today, our industrial sector is under a lot of pressure due to the devaluation of rupee and resulting increase in the prices of imported raw materials; and increase in the prices of crude oil in the international market. Increased interest rates are also increasing costs for industries. In this scenario, it is important to give them a respite from increased costs. The costs of industries can be reduced by decreasing the interest rates. In addition to this, the slowness in the investment can also be eliminated by reducing the interest rates. The fall in interest rates is also expected to increase in new investments as well. This will not only encourage the opening of more industries but may also help the country to deal with the challenges of insufficient infrastructure. Twelfth Five Year Plan is aimed at increasing new investments by 50 lakh crores. It is not only difficult, but rather impossible to achieve the target with high interest rates. Due to all these reasons, it is imperative for the Reserve Bank of India to make a courageous attempt to reduce the interest rates even amidst inflation and stem deceleration in the growth rate of the country.
(The author isAssociate Professor, PGDAV College, University of Delhi.)
Trending Now
E-Paper
Follow our WhatsApp channel