Column: In everyones interest

Written by Bibek Debroy | Updated: Sep 30 2008, 03:55am hrs
Interest rates are difficult to pin down, since there is typically a spectrum, rather than a single number. However, one can often identify benchmark interest rates set by central banks. Websites on cross-country interest rates show that, in Europe, if one leaves out Iceland (15.0%) and Hungary (8.25%), such interest rates range between 2.5% and 5.5%. In North America, the range is between 2.25% and 3.5%. And in Asia-Pacific, the range is between 3.5% and 9.0%, with India at the higher end. The RBI website tells us the deposit rate is between 7.50% and 9.60%, while prime lending rate (PLR) is between 12.75% and 13.25%. How much is the inflation rate The point-to-point WPI (wholesale price index) is neither here nor there, and shouldnt be used for policy purposes. Its a separate matter that there is hype over WPI-based inflation crossing 12%. The trend rate of inflation is no more than around 7%, substantiated by what CSO implicitly accepts as the GDP deflator. Therefore, Indias interest rates are high, both in cross-country comparisons and in terms of what real interest rates should be. In this age of globalisation and integration, the argument that India is a capital scarce country will not wash. In any event, just recently, India has been exporting capital.

There is enough evidence to show that hikes in interest rates have hurt growth. This shows up in both investment and consumption figures, with the latter across-the-board, rather than concentrated in specific sectors. Indeed, had it not been for consumer non-durables, IIP (index of industrial production) would have looked much worse. Manufacturing has been hurt and it has hurt small-scale manufacturing more, since this segment doesnt have access to either global capital or public equity. It is time for the government to plead mea culpa and admit a mistake was made. You dont cool an under-heated economy. Ever since the Indian growth trajectory broke away from a trend of 6.5% and touched 8.5%, there have been arguments that this growth is unsustainable. What that word means is anyones guess, even when it is couched with reference to the environment. Typically, the expression is used when people dont understand what is driving growth. But we do know what is driving Indian growthhigher savings/investment rates, greater efficiency in capital usage, shift away from agriculture and allied activities, export growth, labour input and entrepreneurship. Hence, we know why 8.5% growth is happening and there is no reason why it cant continue in a long-term trend sense, the present downward trend in the cycle is a separate point altogether. As evidence of growth not being sustainable, the inflation bogey was raised.

And it was no more than a bogey, especially if one accepts inflation was 7%, not 12%. To the extent inflation was an issue, it wasnt because supply was short of demand, except agro products, where monetary policy wouldnt have helped. Inflation was largely because of global factors, be it oil or be it other commodities. Even before Wall Streets crisis, these price increases were easing off. At the time of writing, the $700 billion bailout in US is still uncertain. But what is uncertain is the form the bailout will take, the pricing of assets and how it will be funded, not that there will be a bail-out. So we are looking at lower global growth, lower growth in US, dampened oil prices and reduced prices for other commodities, too. The answer to the decoupling argument isnt one that is in black and white. Indias real sector is much more insulated from US developments than one often thinks. But it isnt completely insulated. Hence, perhaps half a percentage point, or even one, is shaved off from Indian growth rates too. It will be more difficult for Indian companies to borrow abroad and some infrastructure projects will suffer, in the sense of being delayed. Decoupling is largely true for all the BRIC countries.

We dont quite know the impact on Indias balance of payments, though we have sufficient forex reserves. Lower crude prices yes, but we also export refined petroleum products and there will be a pull-out of foreign institutional investments. The world has changed since the Asian financial crisis of 1997. In July 1997, forex reserves were $29.8 billion. Today, they are $306.2 billion and this is equally true of several other Asian economies. Will we be preoccupied with the dollar/rupee exchange rate and prevent the rupee from appreciating against the dollar (as it should), regardless of what is happening to other currencies With interest rates certain to drop elsewhere in the world, can we afford this regime of high interest rates, just to ensure that the government can borrow There is an easy question and there is a hard one. Have interest rates in India plateaued out Thats the easy question and the answer clearly is in the affirmative. Will RBI have the guts to cut interest rates Thats the tough question. No one outside RBI and North Block knows the answer to that question. But it certainly should move to drop interest rates immediately. Indirectly, thats our bailout package for the US and world economies.

The author is a noted economist