Dr Ashwani Mahajan
In April also, RBI did not move to reduce policy interest rates and kept repo rate at 7.5 percent and has rather advised commercial banks to reduce their lending rates. Perturbed by continuing high interest rates (except for occasional small reductions), Government has been trying to find ways to reduce then at any cost. Many a times, Finance Minister Jaitely has expressed his unhappiness over high interest rates, as it is causing hindrance to growth. It may be recalled that during NDA-I regime under Atal Bihari Vajpayee, interest rates could be brought down to as low as 5 percent.
Low Interest Rates Boosted Growth
Nation experienced soaring development during low interest rates regime. Rate of growth of industrial development, which was hardly 4.1 percent in 1998-99, reached 8.4 percent by 2004-05. Country witnessed a fast expansion of road network and other infrastructure under Public Private Partnership (PPP) projects. Huge housing demand gave a big boost to housing. Perhaps a major factor which helped the development was low interest rates. For instance at a rate of interest of 8 percent on a housing loan, Equated Monthly Installment (EMI) on 20 years loan of 10 lakh was hardly Rs. 8360, whereas now a housing loan of the same maturity at 12 percent rate of interest, one needs to shed Rs. 11000 as EMI. Expectedly, it led to expansion of demand for cars and other automobiles, consumer durables, housing etc.; apart from encouraging entrepreneurs to expand their businesses.
High Interest Rates Stalled Growth
After 2010, RBI started increasing interest rates due to high rate of inflation. ‘Repo rate’, which was only 5 percent in 2010 increased to 8.5 percent by 2012. In recent months, RBI has started receding repo rate and it has now reached 7.5 percent. Repo rate, the rate at which commercial banks borrow from RBI, is the basis of interest rates regime in the country. We find that lack of demand due to high interest rates, is causing recession in real estate. Road building has virtually come to a halt after NDA-I regime. In the recent years, despite all efforts of the government, there is no interest shown by private players to build industrial corridors and other roads. For all these reasons there has been an all round pessimism in the economy ranging from real estate, to industrial sector, which has been showing zero and sometimes even negative growth.
Economics of Interest Rates
Demand is gaining ground from various quarters to reduce policy interest rates, to take Indian economy, out of recession. Experts believe that economy can come on the track, if interest rates are brought down. There is an ongoing tussle between the Government and the RBI since the days of UPA II. Government has been suggesting the RBI to reduce interest rates; however the RBI was in no mood to oblige the government.
RBI had two arguments in favour of not reducing interest rates. One was that reduction in interest rates may encourage demand to go up and problem of inflation would become even more complex. RBI had been saying that once inflation recedes, it can consider reduction in interest rates. Second argument, against reducing interest rates was that reduction in interest rates may encourage outflow of foreign exchange, which may weaken the rupee further. When the nation is already going through external payment crisis, reduction in interest rates may not be a wise step, it says.
However, Government has been rejecting RBI’s arguments. Now the Government has been actively engaging itself to end RBI’s monopoly to determine interest rates. Even before Raghuram Rajan became RBI Governor, he recommended that control in inflation is an essential condition to reduce interest rate. After him Urjit Patel (then Deputy Governor of RBI) committee had also given the similar recommendations. Now it is being said that right condition for reducing interest rates, is when inflation comes down to less than 6 percent now and 4 percent next year. It is notable that in other countries too, the same condition is being followed.
Proposed Monetary Policy Commission
Although in India, Reserve Bank of India has the power to determine policy interest rates; however to rule out any possibility of arbitrariness, need is being felt for a long time to make the rules regarding determination of interest rates, more transparent. Raghuram Rajan, before becoming Governor of the Reserve Bank of India, recommended in favour of constitution of a Monetary Policy Commission. Similar recommendation was also made by Financial Sector Legislative Reform Committee (Gopal Krishna Committee). Proposed Monetary Policy Commission can help in arriving at a judicious monetary policy after systematically evaluating various types of data. In the process, the allegation of non-transparency would also be dispelled.
Though, there is hardly any disagreement about whether to have a Monetary Policy Commission or not, tug of war is on about, who will have the dominance in the proposed commission; RBI or the Government. Urjit Patel Committee recommended that the Commission may have five members, three representing RBI and two nominated by the Government. Raghuram Rajan Committee recommended in favour of equal number of members, with right of veto to remain with RBI, which it can exercise, but only after assigning a reason for the same.
How will the proposed Monetary Policy Commission look like, what will be the role of RBI and the Government in determination of interest rates in India; only time will tell. However, this is sure that if role of the government in the determination of interest rates increases and interest rates are not determined at the whims of the RBI officials, there will be a pressure to keep the interest rates low.
(The author is Associate Professor, PGDAV College, University of Delhi)
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