We have been hearing quite often that investment in India has slowed down primarily due to the high rate of real interest. Gross fixed capital formation as a proxy for net asset creation has fallen from a high of 32.9% of GDP in 2007-08 to 27% in Q3 of FY14.
This hypothesis has been forcefully contradicted by RBI, which has targeted inflation as the single-most important monetary policy strategy. As a result of which, the RBI claims that the WPI index has come down from 9.6% in 2010-11 to 4.68% in February,which has been made possible by jacking up the repo rate from 6.3% in 2006-07 to 8% in April.
However, the GDP growth nosedived from 9.3% in 2007-08 to 4.7% in Q3 of FY14. The slowing down of investment has only accelerated the rate of GDP’s downward journey, while the number and value of stalled projects has gone up. Blocked investment with no corresponding growth in the output led to an abnormal rise in capital inefficiency.
Interestingly, a study by the IMF has made a statistical analysis (multivariate regression) of the above phenomenon during 1996 to 2012 and has concluded that the rate of real interest can at best explain not more than 25% of the decline in investment and the major part of the slowdown is attributed to uncertainty and deteriorating business confidence, which has been captured by a new measure of economic policy uncertainty.
It has been rightly argued that budgetary announcements (especially on high profile tax policy), delayed project clearances and supply impediments are responsible for the heightened uncertainty.
The result would provide sufficient justification to the hawkish monetary policy of the RBI.One may, however, argue that lack of business confidence is also caused by uncertain product realisation arising out of subdued demand from end users whose capacity expansion or market expansion efforts are jeopardized by high capital costs. In fact, in majority of brownfield expansion of steel plants, the underlying reason for delays in the execution is related to apprehensions of poor demand by end users whose performance is adversely affected by the high cost of market expansion.
It is not known if this indirect cause and effect relationship between the independent variables can be adequately captured by standard statistical tools except by what is known as autocorrelation analysis, which is not an unbiased measure. For tiny, small and medium enterprises, the high cost of credit is clearly a dampener for stability in flow of working capital as well as for investment. If the current business operations are curtailed by high cost of capital, the enthusiasm for seeking capital for future expansion gets equally hurt.
A small reduction in interest rate sends a welcome signal to business collective that the government is there to facilitate growth and expansion. The RBI must wake up to appreciate not the direct impact of real rate of interest but also the indirect effect of damaging the business confidence. A part of the negative growth in manufacturing sector, which is pulling down the industrial growth as well as GDP, can also be attributed to the high cost of capital.
SUSHIM BANERJEE
The author is DG, Institute of Steel Growth and Development. The views expressed are personal