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Does India Inc need a rate cut? - Views on News from Equitymaster
 
 
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  • Feb 16, 2001

    Does India Inc need a rate cut?

    One of the major factors that could be attributed to the slowdown of the US economy are the interest rate hikes by the federal government to cool the overheated economy. Last year, the Fed was worried that the economy was growing too fast. Between June 1999 and May 2000, the central bank boosted interest rates six times to slow growth. Now to bring growth back the fed has already cut the interest rates twice by an aggregate 100 basis points. Do we need one in India too?

    Yes. The index of industrial production released recently gave reasons for concern. The manufacturing sector was slowing down. The manufacturing sector had slowed from a growth of 7% last year (for the period April to December) to 5.9% in the current year. For December the figures for manufacturing were disconcerting at 3.3% compared to 9.3% last year. This is a concern the government should address immediately.

    One of the reasons that could boost the manufacturing sector could be an interest rate cut. The devaluation of the rupee last year had forced the reserve bank to hike interest rates to decrease demand for the dollar. This could have contributed to slowdown of the manufacturing sector. The reason being the manufacturing sector is capital-intensive and therefore, would be more sensitive to fluctuations in the interest rates. And a lower cost of capital would certainly help.

    The economic environment is conducive for a cut in interest rates. Firstly, the forex reserves are sufficiently high. Thanks to the IMD (India millennium Deposit) and FIIs pumping in money into the country. The domestic inflation too is within control. Moreover, the interest rates are coming down globally.

    The prime ministers economic advisory council advocated a 1% reduction in savings rate. This would be matched by a similar cut in the lending rates.

    However, the cons are this move could impact the savings rate. This figure stands at 23% of the GDP. Also the move could lead to an outflow of dollars and impact new inflows from FIIs and NRIs.

    The rate cut would be a short-term measure to boost the manufacturing sector. The real medication is the development of a strong economic infrastructure at a macro and a micro level. At a macro level, the government needs to develop investor friendly policies (that certainly does not mean going overboard). An environment in which investments in the manufacturing sector are a pleasure and not harassment. Improve basic needs of the sector like logistics and energy. But far more critical are the issues at the micro level. The issue of utilisation of manpower. The government needs to create an environment where companies set up shop in India not because of low cost but best skills. The government could take a few examples from the software sector.

     

     

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