Cost of a rate cut delay in India
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI took the first step to ease monetary policy by reducing CRR by 50 basis points on Jan. 24. However, it postponed an interest rate cut, in spite of the advice by the special committee, only to confirm its reputation of being cautious. But excessive caution can also cost the country a pretty penny.
Since then, there have been further developments. Liquidity in the system has been drying up and the RBI has been using open market operations to buy government securities in exchange for cash. That helped maintain the yield on long-term government securities within narrow limits though on short-term debt, like treasury bills, the government had to pay higher interest.
In recent weeks, inflation has climbed down from 9.1 pct in November to 6.7 pct in January. But while the RBI had been quick to raise interest rates with every point increase in inflation, it has been hesitant to cut rates in spite of easing inflation.
The obsession with high rates is causing growth to suffer. Last December, growth in industrial production was a mere 1.8 pct. That was mainly because of the 16 pct fall in capital goods production which reflects the sharp decline in national investment. In July-September 2011, for instance, national investment y-o-y was down from 30.3 pct of GDP to 28 pct. The main reason for holding back investment and income was the sharp increase in interest rates.
Interest rates rose to 8 pct in July 2011 from 5.75 pct in July 2010. Broadly, the rise of 225 basis points in interest rates caused national investment to shrink by 621 billion rupees in the July-Sept quarter of 2011 leading to a GDP loss of 1.03 trillion rupees.
The RBI has been careful to ensure that the interest rate for the government did not increase commensurately. Although the repo rate was up from 4.75 pct at the beginning of inflation to 8.5 pct now, the yield on 10-year government bonds moved in the range 8 – 8.5 pct. The RBI has been buying dollars or buying government securities to replenish liquidity. The full brunt of the rise in interest rates was borne by the private sector either by corporates on bank credit or by individuals on home or car loans.
It is critical that the RBI resume rate cuts. Every week of delay costs in terms of investment and income. The RBI need not wait for its quarterly review to engineer a change. It can do that at any time to correct financial imbalances. The immediate need is a lower rate and it has to be initiated now. Each passing week means a loss of 21.8 billion rupees in investment and 73.6 billion rupees in GDP.