Economic Highlights                                     

New Delhi, 5 May 2011

RBI Un-independent Thinking

RATE HIKE CURBS GROWTH

By Shivaji Sarkar

The new monetary policy of Reserve Bank (RBI) has confirmed that slow-down is imminent, but the prescription --- raising interest rates --- is to put a further brake on the growth process.

Another pernicious decision, under Government pressure, has been its suggestion to link fuel prices to international crude prices. The trend was indicated by the Asian Development Bank (ADB), which had said that the GDP growth in India would come down to less than 8 per cent. The international rating agency Goldman Sachs had predicted it would be around 7.6 per cent. Now RBI puts it at 8 per cent against the Government’s assessment of 8.6 per cent.

Significantly, the RBI has raised the repo rate and reverse repo rates for the ninth time in 15 months. Each such upward hike has led to an increase in interest rates. This is supposed to be the panacea for putting a check on money supply that leads to inflation. It has not worked. There are now multiple channels for money supply, including foreign sources.

Food prices that were rising initially have led to general headline inflation, affecting almost every sector. Thus, the obvious reflection on the index for industrial production (IIP) was inevitable. Manufacturing growth is at a mere one per cent in 2010-11 (19.6 per cent in 2009), capital goods at minus 13.7 per cent (42.9p.c in 09) and consumer non-durables at minus 1.1 per cent (3p.c. in 09). There is only a minor growth in electricity generation to 6 per cent from 5.4 per cent in 2009.

The monetary policy coming a week after the ADB warning was expected to take note of it and moderate the bank rates. It has not happened. The hackneyed way of raising rates is not the solution. The RBI is not unaware of it.

It has not worked for any sector except housing, where it has been able to put a check on speculative activities. It may be recalled that RBI had effected the first rate rise to curb the unethical and un-businesslike practices of the housing sector. The rate rise had a singular effect. Housing prices started reaching its plateau and many unscrupulous companies moved out or closed down.

It is difficult to say whether the housing sector has learnt any lesson. So the policy for this sector needs to be continued. But for penalising one sector, all others need not be treated with the same medicine.

The RBI knows it. In its policy statement, it says, “The pace of industrial activity has been slowing mainly due to the impact of past monetary policy actions and high input prices. External demand too may slow if global recovery slackens”.

This is the concern. Despite knowing about its impact, why is the RBI repeating the prescription? Any physician decides on a course of action taking care of the therapeutic needs of the patient. The RBI is not doing it.

If its concern is the housing sector, it is capable of charting out separate rates for it. But to seek one solution, it is not prudent to throw the baby with the bathtub. A higher reverse repo, at which the RBI gives incentive to banks to park money with it, is supposed to reduce liquidity and demand to cool prices. Banks have done it.

This apart, banks have had a high non-performing asset (NPA), euphemism for bad debt. The RBI has now stipulated that the banks would have to keep a reserve of 40 per cent instead of 35 to balance the NPA so that they do not go bust. The cash reserve ratio though is maintained at 6 per cent almost 25 to 27 per cent of the banks’ money is parked with RBI.

It means that not enough money is available for credit. The banks are yet to come out of the syndrome of lending Rs 68,000 crores to the bidders of the 3G telecom spectrum. It is not a happy situation for the industry, which is being starved of sources for raising its funds.

The rising rates are adding to the cost of the industry, which transfers it to the consumers. The common man spends over 60 per cent of his income on food items. As these get more expensive he cuts down his purchases of all other goods, even textiles and garments. As his purchasing power reduces, industrial and manufactured goods glut in the godowns add to the slowdown.

The mood has been best summed up the Confederation of Indian Industry (CII) President B Muthuraman. He says, “Industry is already reeling under the impact of rising raw material costs and an increase in interest rates will be an added burden”.

It is also likely to have an impact on jobs generation. “We are afraid that with growth slowing down, employment targets will not be achieved”, adds Federation of Indian Chambers of Commerce and Industry (FICCI) Director General Rajiv Kumar.

Besides, the industry with rising inflation also faces pressure on wages, high cost of credit and input prices. The RBI has ignored this in formulating its policy. Its suggestion for raising the petroleum prices “to check the Government’s fiscal deficit” is also misplaced.

The Government does not give a dime as subsidy either to the consumer or the petroleum companies. Each petro price hike enriches it with higher accrual of excise and other taxes. Even now over 50 per cent of the retail petro prices comprise of Central and State taxes. The suggestion of further hike would have a cascading effect as with transport price increases, all other commodities are bound to get expensive.

It seems the RBI has stopped its process of independent thinking to monitor the Indian economy. Apparently, the Government is dictating terms to tailor its policies. Interfering in independent, if not fully autonomous, institutions create severe problems of credibility.

The Governments needs to remember that these are internationally respected institutions. Subverting their autonomy might lead the nation to an abyss. The Government’s interest in such subversion possibly stems from its need to take higher borrowings at less cost to meet its fiscal deficit.

Needless to say, this is not healthy. Unless and until institutions like the RBI are restored their basic freedom, the problems afflicting the country would not be tackled in an effective way. ----- INFA

(Copyright India News & Feature Alliance)