Rate cut must to up growth

In the last five years, rupee has depreciated significantly. The manufacturing sector  is becoming incompetent due to high interest cost.

The Centre has initiated a process for forming a committee which will decide policy rate of interest in the country. This is slated to be a big ticket change; as so far this power rests with the Reserve Bank of India (RBI).

Although the rate of interest  payable on deposits (saving or fixed); and rate of interest levied on loans disbursed by banks is decided by respective banks; however, basic or what may be called policy rates of interests are decided by the RBI. As a policy the RBI decides repo rate, reverse repo rate and bank rate. The RBI also fixes prime lending rate (PLR). The RBI tends to affect rates of interest in the country by effecting changes in repo rate and reverse repo rate.

Barring a few exceptions, in more than last three years, the RBI has been continuously increasing or not reducing rates of interest. Last month again the RBI has chosen not to reduce rates of interest, citing inflationary concerns. Today, Indian economy has been passing through a very difficult situation.

During the last 10 years of the UPA rule, more particularly during the last five years, economic mismanagement, corruption and policy paralysis and inflation have been crossing all limits.  Rupee has also depreciated significantly. The manufacturing sector has shown nearly zero growth continuously for more than three years. The sector is becoming incompetent due to high interest cost.

The RBI gives two major arguments for not reducing the rate of interest. First, reduction in interest rates may spark inflation due to increase in demand and, secondly, to encourage savings we need to have a positive real rate of interest, that is, market rate of interest minus rate inflation.

Even if one accepts RBI arguments in favour of high interest rates, the fact remains that high interest rates have been dampening industrial growth and now manufacturing growth has entered into negative zone, with -0.7 per cent growth in 2013-14.

According to the data published by HSBC, purchasing manager index (PMI) has fallen from 52.4 to 51.0 in September 2014 and further fall to less than 50 may be very disastrous. After negative growth in manufacturing in 2013-14, continued descending manufacturing sector is a cause of major concern today.

It is notable that till sometime back, India, witnessed fairly high rate of growth in industrial sector, however the growth has not been uniform in all industries. Electronic, electricals, telecom, computers and even toys; production could not increase much. Some of these industries got a big setback. The result was that between 2001 and 2013, the import of electrical and electronics, telecom and computers increased by more than 100 times. Many of our industries shifted to China and continuously rising trade deficit reached $ 41 billion by 2013.

Make in India Dream?

In view of the concerns of downfall of manufacturing in recent years, and the need to correct imbalance in industrial sector, new incumbent in the prime minister's chair has given the slogan of “Make in India”, inviting foreign players to come and produce in India.

At the same ‘time , the prime minister has also called upon domestic players to improvise domestic production to build brand India. However, just slogan shouting is not going to serve the purpose, we have to make concerted efforts that should include lowering interest rates. Declining industrial production indicates at existence of excess capacity.

Capacity may be fully utilised by ensuring demand on the one hand and availability of working capital and lowering of interest rates on the other. Once we are able to raise industrial production combating inflation would be an easier task, which would help us in furthering lowering down of interest rates. 

It is an open secret that till NDA I took over, the GDP growth could not exceed 4-5 per cent annually. However, by the year 2003-04, we could achieve a GDP growth rate of 8.5 per cent and this happened because of lowering of interest rates. However, rising interest rates pulled the growth down to 4-5 per cent range once again.

Not only the industrial sector, but infrastructure and service sectors are also getting impacted due to high interest cost. Many of the Public Private Partnership projects are not picking up, as private parties are unwilling to even bid for the same due to high interest cost. Projects like airports, where returns are guaranteed by the government, are only taking off, roads came up during the NDA regime on a large scale, due to low interest cost.

The RBI is not able to come out of its conventional thinking about inflation-based monetary policy, especially about deciding on interest rates. Howsoever good its arguments may be, the fact remains that there in an urgent need for doing something drastic to come out of this mess.

Central banks all around the world are adopting unconventional policies. Example of quantitative easing (QEs) as adopted by Federal Reserve of the US is one such example of unconventional and out-of-the-box policies. The RBI should also invent such policies to reduce interest cost in the economy. As the RBI is not willing to take the call, there is a thinking emerging in the government circles for taking over the power of deciding on interest rates.

We must understand that, this is situation of act or perish and we need to break this impasse by reducing interest rate at any cost.