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Friday, August 10, 2012

Interest rate cut is not the Panacea for India's growth.

“Interest rates are high… Sometimes it is necessary to take carefully calibrated risks to stimulate investment”, said the new Finance Minister, P. Chidambaram, perhaps to send a positive signal to the uneasy investors and businessmen. 

He also said that appropriate action would be taken to address fiscal deficit, inflation and controversial tax laws. Obviously, India Inc is jubilant of the remarks despite there being no specifics, for it is backed by the Finance Minister’s past records. 

These remarks indeed appear to be more as the objectives of the Finance Minister. For, the reality is different: the country appears to be heading for a severe drought, which obviously calls for lot of spending under creation of rural employment opportunities and their expansion. Farmers are also to be helped to replant their fields. Provision of drinking water in the countryside will demand huge budgetary support. All this welfare spending obviously results in fiscal expansion. 
That aside, the next general elections are hardly 20-months away.  It means, again an expansionary fiscal policy pursuit. Further, he didn’t say anything about decontrolling the price of diesel, kerosene and gas. Nor did he say anything about any proposal to cut subsidiaries under fertilizers. All this cumulatively makes one wonder if there is any scope for cutting down the fiscal deficit in today’s context. 

It is against this background that the statement of the Finance Minister to cut interest rates is causing anxiety. Some economists are indeed wondering if what the Finance Minister meant is to make the RBI deliberately cut the interest rates with scant regard to the ground realities.  

Their anxiety is not ill founded, for the global economy is no way encouraging. Indeed it is on the brink of another recession: The WGP forecast of the World Bank for the year 2012 is 2.6% and 3.2% for 2013. A greater chunk of this is expected to be contributed by developing countries and the transition economies. The US, which is saddled with persistent unemployment of 8.6% coupled with low wage growth, is obviously suffering from no rise in aggregate demand. Therefore, its growth rate is projected hardly at 1.5%. The Euro zone, which is being haunted by the sovereign debts crisis, is forecasted to record, at best, a positive growth of 0.7%. Problems are thus multiple and inter-connected which means the World Economy has still not come out of the quagmire. 

Against this backdrop, the Central Banks of developed countries are continuing with their policies of monetary flooding with a hope to stimulate growth. But this appears to be all set to worsen the global economy further. Unfortunately, there is a mad clamoring for such monetary policies in India too from the business quarters, for they consider low interest rates as the panacea for stimulating growth. 

But what these lobbyists must bear in mind is that India is not what Europe is or for that matter the US is. For, we are suffering from a high growth and high inflation phenomenon, while the developed countries are facing low growth and low inflation.  Hence, aping their monetary policies may prove disastrous for us. 

These lobbyists of quantitative easing must remember that our fiscal deficit is already at 5.9% for the fiscal 2012. The current account deficit stood at 4.2%. Inflation is almost persistent at 6.5%. The core sector numbers have already slipped to 3.6% in June 2012. Exports declined by 5.45%. Rupee is depreciating. Monsoon rains are not encouraging. In such a gloomy scenario, cutting down interest rates can prove to be disastrous for the common man.  

So what we need today is not mere anodyne statements from the government, but concrete action—action that ignites “animal spirits” to bring down inflation by addressing the supply-side constraints, to reduce fiscal deficit by eliminating subsidies that are unwittingly benefiting even the rich, and to wither away the consequences of the impending drought by launching requisite welfare measures, even at the cost of fiscal deficit, while letting the RBI do what it deems fit under the monetary policy. 

Indeed such letting the RBI to be independent makes it more accountable to the nation! 


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