Will the RBI change its mind?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI seems to be almost obsessed with the high rate of interest. At the January review of credit policy it remained silent and on March 9 made an unscheduled announcement about the cut in CRR to make up for the shortfall in liquidity. Though this infused 480 billion rupees into the banking system, it did not ease interest rates in spite of persuasion by the Finance Ministry.
The RBI hesitates to shave off the repo rate because inflation is still around 7 percent though down from its peak of 11 percent two years back. But the high repo rate is causing development to slow down. That is visible from many unmistakable signals. Last February the growth in industrial production dropped to 4.1 percent; in July-September 2011 national investment y-o-y was down from 30.3 percent of GDP to 28 percent and the GDP growth itself from 8.4 percent to 6.9 percent. Broadly, the 225 basis points rise in interest rates caused national investment to shrink by 621 billion rupees, leading to a GDP loss of 1.03 trillion rupees.
The slowdown in the economy is not limited to investment and income alone though these are critical. It has a secondary effect on other parameters, more importantly employment generation. Each percent drop in GDP growth means denying possible employment to 1.5 million workers.
A cut in repo rate has become vital to reverse the drift in development. Two questions are relevant. First, when should the repo rate be reduced? And, second, what should be the extent of reduction in repo rate?
Going by the experience of 2008-09 when the economy was in similar conditions, a quick reversal of GDP growth became possible because the repo rate was reduced from 9 percent to 4.75 percent in just a few months.
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 percent at the beginning of inflation to 8.5 percent now, the yield on 10-year government bonds moved in the range 8 – 8.5 percent. But the full increase in rates was passed on to private businesses and individuals.
It is critical that the RBI should cut the repo rate and should start doing that now. For, every passing week means a loss of 21.8 billion rupees in investment, 73.6 billion rupees in GDP and 30,000 in employment. The deeper the cut, the sooner the economy will recover. But the rise in repo during inflation was in baby steps; and the fall may not be faster. At best a 25 bps is likely next week when the RBI goes in for its quarterly review. That is not enough but can at least be the beginning.