Don’t look for silver bullets, all-round reform is needed

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Updated: August 13, 2019 2:05:52 AM

While repo rates may be the same now as they were in 2010, he argued, given consumer inflation is dramatically lower today—3-3.5% this year versus over 13% then—the real repo was minus 8.1% in 2010 versus plus 2.6% now; so RBI needs to do a lot more.

Nirmala Sitharaman, interest rates, repo rates, RBI, reserve bank of india, consumer inflation, ease of doing businessIn which case, while lower interest rates will help industry, it is not clear there can be a quick or sharp reduction even if RBI cuts repo rates as fast as most want. (Reuters)

One of the top-most agenda items for most of the industrialists who met finance minister Nirmala Sitharaman last week was the lowering of interest rates. Why these worthies chose to bring this up with the FM is a bit odd since it isn’t quite clear how the government can speed up the process considering it is the by-product of the RBI cutting repo rates, the amount of liquidity in the system, the asset-liability position of banks etc. Even before this, economists like Surjit Bhalla have been arguing that, along with a cut in corporate tax rates, an interest rate cut is one of the two silver bullets to fix the current economic slump. Indeed, in a column in this newspaper, Bhalla rubbished ‘sheep newspapers’ who, like sheep, all praised RBI for its repo cut last week and said, with the central bank doing as much as it could, the ball was now in the government’s court. While repo rates may be the same now as they were in 2010, he argued, given consumer inflation is dramatically lower today—3-3.5% this year versus over 13% then—the real repo was minus 8.1% in 2010 versus plus 2.6% now; so RBI needs to do a lot more.

No one can doubt that cutting interest rates will help industry. But, apart from the fact that even if the repo rate is brought down to zero, real rates still can’t fall to minus 8.1%, there are real issues about transmission to ensure interest rates fall by an equal amount. For one, banks can’t lower rates till they can get deposits at much lower rates, and that can’t happen in a hurry if the government keeps rates on small savings high; and as long as bank NPAs remain high, even if lending rates to safe projects—like retail housing—come down, banks will probably increase spreads for slightly riskier lending. There is, for the same reason, the issue of how quickly, if at all, banks will like to take over lending done, till now, by NBFCs. And if the public sector (central and state governments and central PSUs) borrowing is around 8.5-9% of GDP as JPMorgan’s chief India economist Sajjid Chinoy estimates, while financial savings of households are just around 7% of GDP, this also means the private sector is getting crowded out. In which case, while lower interest rates will help industry, it is not clear there can be a quick or sharp reduction even if RBI cuts repo rates as fast as most want.

But, and this is important, given so many other deep-seated problems, it is not clear that merely cutting interest rates will move the needle. In telecom, apart from serious allegations of bias, the sector is near-bankrupt thanks to rapacious government levies and spectrum pricing; till this is fixed, how will fresh investment flow? In the oil and gas sector, till market pricing is available to most of the production, investments can’t rise significantly. In other sectors, it is wage-rigidity that is the problem, the high cost of infrastructure compounds this problem in other sectors, along with corporate tax rates that are much higher than those in competing nations. It is bankrupt SEBs in the case of the power sector, high government levies and the public sector monopoly in areas like coal in the mining sector; the fact that the government can change the law, as was seen after Walmart spent $16bn to buy Flipkart or in the decision to levy capital gains taxes on FPIs, also shows the risks of doing business continue to be high. Not surprisingly, given India Inc’s desire to rate budgets as 11 or 12 out of 10, few industrialists brought up these issues with the FM.

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