RBI makes the right policy call

June 20, 2012

(Rajan Ghotgalkar is Managing Director of Principal Pnb Asset Management Company. The views expressed in this column are his own and do not represent those of either Principal Pnb or Reuters)

The Reserve Bank of India’s (RBI) monetary policy states that “..it is relevant to assess as to what extent high interest rates are affecting economic growth. Estimates suggest that real effective bank lending interest rates, though positive, remain comparatively lower than the levels seen during the growth phase of 2003-08. This suggests that factors other than interest rates are contributing more significantly to the growth slowdown.”

One could not have placed this argument with any more clarity.

This can possibly be illustrated better by using representative numbers.  Assuming the prime bank lending rate at 14.75 percent per annum, and we reduce the impact of WPI at 7.6 percent, the ‘real’ lending rate will be 7.15 percent per annum which on a post-tax basis will be 5.58 percent per annum, considering it’s a business paying tax at 22 percent and can expense its interest costs.

On the other hand, the retail deposit rate applicable to domestic household savers at 8.5 percent per annum will correlate to the Consumer Price Index of 10.4 per annum, giving a ‘real’ deposit rate of negative 1.9 percent. Assuming an average 20 percent tax rate, a domestic saver will get a negative real rate of 3.6 percent per annum.

How can we expect to attract household savings back into financial assets and how can we justify a further reduction in lending rates?

The RBI in its words had ‘front loaded’ the reduction by the 50 basis points cut in April and in doing so, had very clearly hit the ball back into the government’s court by not mincing words in expressing the need for fiscal consolidation in driving down inflation.

Inflation is back to its customary monsoon dance and we are back to talking about selling our family silver, i.e. PSU disinvestment, to tackle the fiscal deficit.

The liberalisation of the 1990s can at best be considered a beginning for the real reforms which should have followed. Instead, we were left grappling with the pulls and pushes of irreconcilable vested interests which emerged from carefully crafted minority-based vote bank politics.

Somewhere down we seem to have missed executing the welfare and development agenda for the people whilst having succumbed to economic populism of the worst kind.

The RBI policy rightly points to the need for development of supply side infrastructure. This will mean doing a lot more than making licenses redundant and retrospective tax amendments.

Subsidy and welfare grants have to be administered using technology so that they reach only the deserving which in itself will ensure huge savings without the need for cuts.

The real reforms, I believe, are more internal than external.

India needs to first and foremost make itself a ‘free trade zone’ by getting GST through and dismantling the agriculture marketing laws. Speed up exploitation of energy resources by executing transparent bidding processes. Similarly, execute fair and transparent land acquisition processes.

The multi-brand FDI and insurance reforms can come later.

Having now gone so far to perpetuate vote bank politics, it may not be easy for us to wish away the growing strengths of regional and state-level parties. Coalition governments may be the new norm and India may well accept that the shortest route to execute its development agenda may be at the state level in the best interest of federalisation.

The central government should get back to debating, enacting laws and engage in enablement rather than in controlling except what is most needed for national interest.

RBI Governor Duvvuri Subbarao deserves our admiration for standing up to the din and noise emanating from the more vocal India.

He has rightly put consumer inflation on the top of the policy agenda recognising that in our country, placing food on the table still remains a lot more important than consumer durables and automobiles — even if it means sacrificing a percent of GDP growth in the shorter term.

Our central bankers have once again disproved the naysayers by providing hard evidence that India’s financial policy making is in the able hands of independent institutions. So long as this is true, the India growth story will remain firmly intact.

One comment

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Well & truly said Sir. Not only had RBI stated indisputable reasons for holding interest rates, it emphatically also sent a message that decisions are taken independently and not swayed by the ‘loud’chorus of an anticipated rate cut which included inter alia the FM and others.

Posted by aarvee | Report as abusive