The Case for Raising Interest Rates


This post is in the context of the current economic situation in India.

There was a report yesterday in The Times Of India that the Government of India is prodding the Reserve Bank of India (RBI) to drop interest rates in the upcoming review of interest rate policy.

I do not think that the RBI will yield to government pressure, having stood tall over the past many quarters with an independent and fair analysis of the state of the economy. There is no issue with the government wanting to raise the GDP growth rates, but it must first reduce the current account deficit to a Parliament-mandated target.

While Finance Minister Mr P Chidambaram has worked hard on the Budget that he unveiled last month outlining measures to reduce the deficit, still much needs to be done. India was never short of policy planners and strategists – but India always had a problem with execution.

It is commendable that the Finance Minister has not yielded to an election year scramble for spending tax-payer money on populist measures, and has controlled the urge to spend more. But he needs to do more to ensure that the inflation is brought under check by eliminating supply-side bottlenecks which continue to hobble the Indian economy.

What has the government done to at least reduce the inflation by couple of percentage points ?

NONE, nothing that anyone can see.

Infrastructure wreaks under the ever-increasing load, and there is no determination on the part of the various ministries to concentrate their efforts on removing all hurdles on the way to growth.

The blame of slowing economic growth cannot be laid at the doorsteps of the RBI.

In fact, I would argue that the RBI should now declare a upward bias on interest rates, since the consumer inflation is again going up. Real estate prices are skyrocketing when the entire economy is decelerating. I don’t think India will exceed 6.2% GDP growth rate in the year starting in April 2013 – at best it would reach 6.0%. RBI need not throttle growth but it should warn the government and the business leaders that it won’t drop interest rates to oblige their priorities and put the common man on the mat.

Government can do a lot more than what they have done so far. It has been a total systemic failure of economic policy making at the senior levels of the government which boasts of Dr Manmohan Singh as the architect of the 1991 economic reforms.

But, the spectre of 1991 is returning to India, and all our foreign currency reserves and gold reserves won’t be able to save us this time also.

Reduce the deficit below 4.6% and then something can be done on the interest rate policy – till such time, growth has to contend with inflationary pressures ever-present in the economy.

Cheers,

Vijay Srinivasan
10th March 2013

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s