A reduction in key policy rates may not necessarily improve investments and spur the economy, as the current slowdown has been largely stoked by government policies and low domestic demand, according to a Crisil study.
“The recent slowdown in economic growth and investment in India have little to do with high interest rates. The slowdown is largely because of government policy 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,” the study said. It said investment growth, particularly in the private corporate sector, declined in FY13 and FY14 despite low real interest rates. During this time, the policy rate in real terms (repo rate minus retail inflation) has been negative, and real lending rates averaged 2.4%, substantially lower than the 7.4% seen in the pre-crisis years (2004-2008). Yet investment growth dropped to 0.3%, down from an average 16.2% seen in the pre-crisis years.
The study blamed declining returns for the slowdown in investments. “The average rate of return on corporate investment (non-financial firms) — as proxied by return on assets — fell sharply to 2.8% in fiscal 2013 and 2014 from nearly 6% in the pre-global financial crisis years. If the return on investments already made has fallen so sharply, expected return on investments planned but not yet made would have plummeted even more, rendering them unfeasible,” it added.
“Policy uncertainty, lack of clearances, and weak demand are the real reasons (for the slowdown). And high inflation, by discouraging consumption demand, eroding export competitiveness and raising input costs for corporates, has made the situation worse,” it said.
“On its part, we believe the 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,” it said.
Clamour for lowering the lending rates to prop up the economy intensified recently after wholesale price inflation dropped to an almost five-year low of 2.38% in September and retail inflation, at 5.46%, hit the lowest since its inception in January 2012.