CRISIL Research study shows investments have slowed in times of lower interest rates. What matters more is the business environment, or the expected return on investments.
The chorus on an interest rate cut to revive the economy has got louder with the recent climb-down in inflation. To be sure, the monetary policy tool of cutting the interest rate is conventionally used to energise a flagging economy.
But this does not hold true under all circumstances. Our study shows that factors behind the recent slowdown in economic growth and investment in India have little to do with high interest rates.
Investment growth has slowed down sharply even though policy rates have been negative in real terms and real lending rates have averaged less than 3%.
The primary reason for this slowdown is a sharp fall in the expected return on investments due to policy uncertainty and slowing domestic demand. In such a situation, leaning on monetary policy to revive investments will yield little benefit. And, it carries the risk of reversing the recent gains in inflation, which, in any case, is nothing much to write home about.
Therefore, we believe that the government should continue to improve the policy environment to raise the expected return on investment.
On its part, the Reserve Bank of India (RBI) should continue its fight to stabilise consumer price inflation below 6% and that would require standing pat on the repo rate. Lower inflation will help revive consumption demand and reduce input costs, boosting return on investments.