India must reinvent interest policy by surmounting past legacy | The Financial Express

India must reinvent interest policy by surmounting past legacy

In developed nations, consumption demand is closely linked with the interest rate. Their savings and investment needs are low. Unlike India, they didn’t have chronic problems of inflation and currency weakening in the past years.

India must reinvent interest policy by surmounting past legacy
Currently, in India, average productive capacity utilization is below 75% and hence, inflation is not due to excess demand over supply. (Representational image)

By R.P. Gupta

During Covid years 2020-22, RBI had reduced Interest rate and infused liquidity; that helped in the revival of GDP growth. Meanwhile, inflation entered along with weakening of Rupee. In sequel, RBI has chosen for repeated hikes of Interest rate with a mild doze liquidity curb. This is in line with the mandate and past legacy. But this might impede investment vis-à-vis GDP growth and thus aggravate job crisis.

In developed nations, consumption demand is closely linked with the interest rate. Their savings and investment needs are low. Unlike India, they didn’t have chronic problems of inflation and currency weakening in the past years. Unemployment and poverty ratio is relatively lower. Considering higher per capita income, they can easily afford temporary adversities like Covid and Russia-Ukraine war.

Such situation doesn’t prevail in India.  India must diagnose other causes of inflation and weakening of Rupee and chose appropriate remedy. For this, India must re-invent “interest policy” striking balance between the growth, inflation and Rupee weakening. Interest rate in India has been historically higher than the developed nations which impedes investments in infrastructures and affects “economic efficiency” of nation.

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Currently, in India, average productive capacity utilization is below 75% and hence, inflation is not due to excess demand over supply. If so, how the tight monetary policy can resolve inflation? While examining data of inflation and interest rate in past two decades, there is no evidence of direct relation of interest rate with inflation, as detailed in my book, “Turn Around India” (2015 edition).

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Yes- abnormal fiscal expansion for non-capital expenditures crafts monetary expansion and invites inflation since; such money is not arising from the productive income. However, fiscal expansion in India during Covid was too small compared to the developed nations and it is now tapering down.

Unlike other nations, there is no major shortage of food in India. Imported crude oil price is not at the highest level. Yes-imported thermal coal price is at highest level affecting the cost of power and metals. This could be resolved by increasing domestic production since; India has huge coal deposit. Yes- Rupee fall is too high which has impacted the domestic price of imported energy, edible oil, fertilizer, medicine raw material and electronic chips.

In my view, current inflation in India is mainly due to “Cost-push” affect clubbed with the steep fall of Rupee. High Trade deficit (goods & services) and Current account deficit (CAD) are primarily responsible for Rupee fall. High taxes (GST, Excise, Cess, Mineral taxes etc.) have accelerated adversities; that needs urgent policy intervention.

We must acknowledge that; the cost of basic inputs such as capital, energy, logistics and minerals in India is too high while comparing with major economies. In addition, the taxes on energy and minerals are increased in unprecedented manner. Its impact travels to the production cost of entire goods and services causing inflation and trade deficit. The impact is cumulative giving spiralling effect on both counts and also weakening Rupee. Monopoly and speculation aggravate the problem. In sequel, inflation and currency weakening has been a chronic problem in India since many years with occasional flare up. This is not found in most of the developed nations.

In other words, the “economic efficiency” of India is relatively lower since many decades. This doesn’t depend up on the producers alone but upon the whole gambit of policies and business regulations. The monetary policy alone can’t resolve this chronic problem. India needs radical reforms surmounting past legacy along with a composite plan for meeting its investment needs.

The impact of higher cost of capital (interest) on the infrastructures (energy and logistics) and core sector is significant which travels to entire economy. Total interest cost of the State and Central Government might be about 25-30% of revenue receipts. That compels Government to increase tax or borrow more. Combined tax (Both state & central) is already up by 2-3% of GDP. In such circumstances, regular inflation is inevitable.

Repeated hikes of Interest rate shall be counter-productive; that needs reversal irrespective of on-going inflation. Savings in bank deposits may be protected through new fiscal incentives. For surmounting the chronic problems of inflation and Rupee fall, India must improve economic efficiency and resign from the regime of high interest and weak Rupee through structural reforms. India has such hidden potential; that must be acknowledged with conviction and be achieved with policy interventions.   Thereafter, the GDP growth will be consistent and the new jobs shall be created every year. Yes- dependency on the so called “essential imports” must be reduced and/or replaced with domestic production on best effort basis to deal with any global turmoil in future; that will give India its right place among the world fraternity.

(R.P. Gupta is Author of the book Turn Around India. Views expressed are personal and not that of financialexpress.com)

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First published on: 08-11-2022 at 14:50 IST