Strangling Growth of Indian Economy

Yesterday, the RBI (Reserve Bank of India) raised its policy rate by 0.25% to 8.25%. It is the 12th such continuous interest rate hike by the RBI, which started in March 2010.

While the RBI’s action was largely expected in the light of the rising inflation (the inflation touched 9.78% in August), it was not really warranted. The global economy is in major trouble, European nations are failing, demand world-wide is shrinking, the U.S. economy is tottering, and high interest rates / inflation has dented the growth rate of the Indian economy. Given the challenges faced by India, it is high time that the RBI took a pause and let the economy stabilize.

Monetary policy acts with considerable delay as is widely known. The economy is just reacting to the previous interest rate hikes. GDP growth has fallen for the first quarter of this year (April to June 2011) to less than 8%, the first time it did in the past six quarters. Instead of letting the economy stabilize and take a breather, inflationary concerns seem to be dominating RBI’s thinking.

If accelerating demand is the main force driving up the inflation, then that thinking may be right. But India has supply side constraints affecting the economy and the inflation, rather than galloping demand. So, how is it reasonable for a group of economists to make a decision without consulting the stakeholders in the larger economy ? Of course, one can argue that the monetary policy of a nation cannot be influenced by vested interests. But, here a nation of 1.2B people is getting seriously impacted by dropping economic growth rate, caused mostly by the rising interest rates which is affecting manufacturing and all productive efforts.

While the banks are flush with liquidity, they are not able to find borrowers. Lending activity is shrinking, both for the productive aspects of the economy and at the retail consumer level. Citizens are increasingly becoming wary of investing in capital assets. You cannot blame them when they have to borrow at more than 12% interest rate. Manufacturing companies are also in the same situation. Capex investments will continue to suffer, and it is no wonder Indian industrialists are looking to invest overseas where the situation is conducive for their investments.

In a nutshell, it was not necessary for the RBI to engage in another round of interest rate hike, in the hope of reining in inflation, which is not going to happen anyway. They should have taken a breather and waited for another 45 days, before taking a final call.

I am not an economist, so may be I am not qualified to critique RBI’s action. However, from the perspective of a ring side view of the economy, may be all citizens should take a view of all governmental and institutional actions which could affect them, their lives and the health of the economy as such. There should be a mechanism to convert these citizens’ views into something concrete as a public opinion on policies which affect them.

The Indian economy is now going to be impacted more seriously than ever. It is critical to use a combination of policies rather than just the monetary policy as a tool to control inflation and demand-led growth.

Let us think carefully again whether this interest rate hike was really seriously warranted.


Vijay Srinivasan
17th Sept 2011


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