Dr Ashwani Mahajan
Belying all hopes in its third quarterly review, RBI has once again not only has not reduced repo rate, but have actually increased the same by 0.25 percent points, engineering hike in EMIs for the loans taken by the middle class and not giving an opportunity to the industry to uplift its investment, which was clamoring for a relief in terms of interest cost, making the industry less and less competitive in the last 3-4 years.
After two years of deceleration, rate of growth of GDP declined from 9.3 per cent in 2010-11 to 5 percent last year; and according to national and international agencies, GDP growth may fall below even 4.5 percent in the current year. Manufacturing growth has shown its worst. Whereas, last year manufacturing growth had declined to 1.3 percent, after consistently falling from 15.6 percent in 2007-08, in the first eight months of the current year (April to November 2013), this further declined to -0.2 percent. Agricultural growth is also subdued. Given slow growth of agriculture and negative growth of manufacturing, service sector has very meager possibility to show any better performance. If anything affects growth the most, that is, rising inflation. It is notable that rate of inflation has kept very high in the last three years. One can measure inflation in two ways; one, by wholesale prices and other by consumer prices. No doubt both wholesale and consumer prices have been climbing fast for last so many years; however, Consumer Price Index (CPI) has shown much bigger increase as compared to wholesale price index. For instance rate of inflation was 11.7 percent in terms of CPI and only 8.6 percent in terms of Wholesale Price Index (WPI). If does not mean that consumer prices increased more than wholesale prices. In fact, while making wholesale price index, about 24 percent weight is assigned to food products, while estimating consumer price index, food products have nearly 50 percent weight. Since prices of food products rose much faster than other commodities; rate of increase in CPI looks to be greater than that of WPI.
In its attempt to keep inflation under check RBI has been raising interest rates. Though repo rate was reduced occasionally, it increased from 5 percent in 2010 to 8 percent now. Repo rate is the rate of interest at which banks borrow from RBI. Repo rate generally is the basis of interest rates in the country. Because of rising repo rate, in the last 3 years Interest rates started increasing in the country and by implication EMIs started increasing for the common man. People started putting off their new purchases of homes, automobiles and other common durables, as it was beyond their capacity to pay high EMIs. Those who had borrowed earlier were now paying higher EMIs through their nose. After paying hefty EMI, they are left with much less money to spend on food. They may purchase bare essential food items, however they are forced to cut on expenditure on other commodities and they are forced to defer or even give up purchase of consumer durables like a new car, scooter or TV. Along with that new investments also become expensive. As Investors borrow much less from banks, banks are forced to invest their surplus funds in government securities.
When consumers postpone their purchases or investors their investment; this is a situation of recession. Keynes was an economist, who analysed the situation of recession, concluded that to come out of recession the only solution in to raise the level of demand. The demand can be raised by increasing consumption expenditure or increase in investment or both. Another way to raise demand, which was favoured most by Keynes, is increasing government expenditure. However in present circumstances there in a limit to increasing government expenditure. It is understandable, that to raise expenditure on consumer durables and investments, we need to reduce interest rates.
However RBI has its own reasons for not reducing interest rates. Its first argument is that, increase in demand resulting from reduced interest rates may fuel the inflation further. Secondly interest rate is just not a rate at which borrowing takes place; it also serves as an incentive for saving. If rate of increase in price level is more than the interest rates as deposit, that would act as a disincentive to save more. Notwithstanding all these arguments, in the present scenario where sentiments are lying low in the country about growth, there is an urgent need to give a chance to growth.
Finance Ministry’s View
In the past also there has been a lot of tussle between RBI and the Ministry of Finance, Government of India. Finance Ministers criticism of the RBI and its past governor is no secret. However RBI has failed to oblige the ministry so far. Recently Maya Ram, the Finance Secretary, has once again said that the RBI has to think and act out of box. According the Finance Secretary, present day inflation measured by Consumer Price Index, is primarily driven by increase in prices of food products; and RBI’s monetary policy hardly has a role in controlling this food inflation. Therefore there in hardly any legitimacy in keeping the interest rates high (in view of food inflation).
Pressures on RBI
In view of the arguments given, there was tremendous pressure on the RBI to reduce the interest rates. In the month of December, 2013, inflation rate in terms of wholesale price index was at 6.16 percent, while food inflation was at 13.7 percent, as compared to nearly 20 percent in November. Raghu Rajan himself has revealed his intention to reduce the rates, several times. However, in the meanwhile, report of the panel, under Urjit Patel, RBI’s Deputy Governor, came in the third week of January, which once again forced the RBI to take the stand that monetary policy should be centered on control of inflation. According to the report, longer term target inflation rate should be of 4 percent with a band of +/- 2.0 percent and at present nearly 10 percent inflation rate is much higher than this target. With relief in inflation rate in December RBI had an opportunity to reduce interest rate; however in the meanwhile this report came in, which perhaps came in the way. Another development, which affected RBIs decision, was retention of high interest rates in other emerging economies, which are facing erosion in the value of their currencies. With the danger of further depreciation of Indian rupee looming large, RBI deemed it fit to raise the policy rates, rather than reducing the same.
It seems, failure of fiscal policy, has been coming in way of a monetary policy which could encourage growth, as RBI has to fight inflation, all the time, rather than encouraging growth. Government of India and RBI should both sit together and find ways for growth oriented monetary policy, by defeating inflation through boosting supplies and keeping fiscal deficit and thereby money supply under check.
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